Finance Exam 3- Chapter 10- Making Capital Investment Decisions

1. Relevant Cash Flows- Parker & Stone, Inc. is looking at setting up a new manufacturing plant in South Park to produce garden tools. The company bought some land six years ago for $6 million in anticipation of using it as a warehouse and distribution site, but the company has since decided to rent these facilities from a competitor instead. If the land were sold today, the company would net $6.4 million. The company wants to build its new manufacturing plan on this land; the plant will cost $14.2 million to build, and the site requires $890,000 worth of grading before it is suitable for construction. What is the proper cash flow amount to use as the initial investment in fixed assets when evaluating this project?

$21,490,000 cost of land= 6.4 million cost of building = 14.2 million cost of grading = 890,000 all relevant cash flows

1. Calculating Projected Net Income - A proposed new investment has projected sales of $830,000. Variable costs are 60% of sales, and fixed costs are $181,000; depreciation is $77,000. Prepare a pro forma income statement assuming a tax rate of 35%. What is the project net income?

$48,100 830,000 -498,000 -181,000 -77,000 =74,000 -25,900 =net income

OCF from Several Approaches- A proposed new project has projected sales of $108,000, costs of $51,000, and depreciation of $6,800. The tax rate is 35%. Calculate operating cash flow using the four different approaches. (first you'll need to calculate the pro forma income statement so you have the numbers you need for the equations) Most Common Methond? Bottom-Up Approach? Top-Down Approach? Tax Shield Approach?

NI= 32,630 Most Common Method OCF=EBIT+Depreciation -Taxes 50,200+6,800-17,570 =$39,430 Bottom-Up Approach OCF = Net income + Depreciation 32,630+6,800 =$39,430 Top-Down Approach OCF = Sales - Costs - Taxes 108,000-51,000-17,570 =$39,430 Tax Shield Approach OCF = (Sales - Costs)(1 - tax rate) +(tax rate x Depreciation) (108,000-51,000) *(1-.35) +(.35*6,800) =$39,430

With an OCF = 1,631,500 and a initial investment = 3.9 million calculate the project's NPV and IRR. Assume the required rate of return on the project is 12%.

NPV= $18,587.71 Accept this project (because it is positive) IRR = 12.28%

With a OCF = 1,631,500 and a initial investment = 3.9 million. Suppose the project requires an initial investment in net working capital of $300,000, and the fixed asset will have a market value of $210,000 at the end of the project. The tax rate = 35%. What is the project's year 0 net cash flow? Year 1? Year 2? Year 3? What is the new NPV?

NPV=$29,279.79 IRR= 12.39% This is larger than the last one because we get something back, the 136,500, at the end of the year. The working capital would actually decrease NPV if there was not an terminal cash flow from selling the fixed asset. Sale of asset = 210,000 - (210,000* .35(taxes)) 0 1 2 3 |---------------------|---------|-----------------| -3,900,000 1,631,000 1,631,000 1,631,000 -300,000 +300,000(nwc) =-4,200,000 +136,000(sale) =2,068,000

Calculating OCF- Fill in the missing numbers and then calculate OCF. Sales $824,500 Costs ? Depreciation -$126,500 EBIT =$159,100 Taxes (34%) ? Net income = ?

OCF = EBIT + Depreciation - taxes= 231,506

Calculating Project OCF- Summer Tyme, Inc. is considering a new three-year expansion project that requires an initial fixed asset investment of $3.9 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which it will be worthless. The project is estimated to generate $2,650,000 in annual sales, with costs of $840,000. If the tax rate if 35%, what is the OCF for this project?

OCF= 1,631,500