Chapter 10 finance test materials

Delroy inc wants to buy a new machine the cost of the new machine is $140K An infusion of $4K in net working capital will be needed at the time of installation. The project will increase revenues by $85K per year, and operating costswill increase by $30K per year Simplified straight-line depreciation is used; asset's net book value will be deprec'd to 0 Class life (useful life) is 5 years, and the firm is planning to keep the project for 5 years. Anticipated market value at year 5 = $50K 14% required ret.; 39% marginal tax rate.

-140k = net fixed assets (-because outflow) -4k = change in net working capital (- because outflow) 85k = Incremental revenue -30k = Incremental costs 39% = Tax rate Dep = /5 which is the number of years gain = 50k

Initial cash flow of the Delroy problem

-change in NFA -Change in NWC -------------------- cash flow at T=0 OR -140K -4K ------ -144K

Your firm is contemplating the purchase of a new $535,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $30,000 at the end of that time. You will save $165,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $60,000 (this is a one-time reduction). If the tax rate is 24 percent, what is the IRR for this project? Lots of downvotes so maybe dont trust this one

After tax cash inflows = 165,000 x (1-.24) = 125,400 Depreciation expense = 535,000/5 = 107,000 Year 0: 535,000 year 1-5: 125,400 (annual after tax savings) + 107,000(annual depreciation expense) =232,400 year 5 = 30k (salvage value) + 125,400 (after tax savings) = 155,400

Esfandairi Enterprises 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 time it will be worthless. The project is estimated to generate $2,650,000 in annual sales, with costs of $840,000The tax rate is 35% percent and the required return on the project is 12 percent. What is the project's NPV?

Asset cost = 3,900,000 Salvage value = 0 Project life = 3 Annual sales = 2,650,000 Annual costs = 840,000 Tax rate = 35% Required return = 12% _______________ Depreciation = 3,900,000/5 = 1,300,000 EBIT = 2,650,000 - 840,000 - 1,300,000 =510,000 Tax expense = 510,000 x 35% = 178,500 Net income = 510,000 - 178,500 = 331,500 OCF = 331,500 + 1,300,000 = 1,631,500 N = 3 I/Y = 12 PMT = 1,631,500 FV = 0 CPT PV = 3,918,588 NPV = 3,918,588 - 3,900,000 Answer = 18,588

Calculating Salvage Value [LOI] Consider an asset that costs $745,000 and is n. depreciated straight-line to zero over its eight-year tax life. The asset is to be used in a five-year project: at the end of the project, the asset can be sold for $135,000. If the relevant tax rate is 21 percent, what is the aftertax cash flow from the sale of this asset?

Book value at year 5 = Asset cost - accumulated depreciation accumulated depreciation = 5(745,000)/8 AC = 465,625 Book value at 5 = 745,00 - 465,625 = 279,375 Now the machine is sold for $135000 when its book value is $279375. This would amount to a capital loss of -$144,375 (135,000-279,375). This capital loss would lead to tax savings of (21%*144,375) $30,318.75. 135,000 - 30,318.75

Terminal cash flows

Capital spending and change in networking capital Or -capital spending Gain/loss on sale of assets -tax expense(if gain) -change in net working capital ------------------------------------ Terminal Cash flows Or filled in -0 + 50k 19.5k (50k x .39) - (-4) Since net working capital is - it turns + ----------------------------- terminal flows = 35.5k

OCF

EBIT + Depreciation - Taxes

Operating cash flow

EBIT + Depreciation - Taxes

change in NWC

Ending NWC - Beginning NWC current assets - current liabilities = NWC

Dog up franks is looking at a new sausage system with an installed cost of 385,000. This cost will be depreciated straight line ro zero over the project's five year lifetime at the end of which the system can be scrapped for 60k the sausage system will save the firm 135,000 per year in pretax operating costs and the system requires an initial investment in net working capital of 35,000. If the tax rate is 21% and the discount rate is 10% what is the NPV

Installation cost = 385,000 Pretax salvage value = 60,000 Operating cost per year = 135,000 Inital NWC = 35,000 Tax rate = 21 Discount rate = 10% Step one depreciation 385,000/5 = 77,000 - annual depreciation charge After tax salvage value = 60,000(1-21%) = 47,400 OCF = 135,000(1-21%)+21%+77,000 =122,820 PMT = 122,820 N = 5 I/Y = 10 FV = 35,000 + 47,400 PV = 516,748.35 NPV = 516,748.35 - 385,000 - 35,000 Answer = 96,748.35

In the previous problem, suppose the required return on the project is 12 percent. What is the project's NPV?

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Esfandairi Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2,450,000. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,590,000 in annual sales, with costs of $1,610,000. If the tax rate is 21 percent, what is the OCF for this project?

OCF = (Sales - costs - depreciation) x (1-tax rate) + (depreciation) Depreciation = 2,450,000/3 = 816,666 (2,590,000 - 1,610,000 - 816,666) x (1-.21) + 816,666 OCF = 945,700

Annual cash flow

Operating cash flow +EBIT -Taxes +Depreciation OR Incremental Revenue -incremental costs. = EBIT -Depreciation expense ------------------------ Earnings before tax -Tax expense on EBT = Taxes ------------------------- Incremental net income +Dep expense --------------------------- Annual Cash flows OR filled in 85K -30K -28 (144/5) ------------ 27K (85-30-28) -10,530 (27k x .39) -------------------- 16,470k (27k-10,530) 28k -------------------------- Annual Cash flows = 44,470

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 $2.8 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 $3.2 million. The company wants to build its new manufacturing plant on this land; the plant will cost $14.3 million to build, and the site requires $825,000 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? Why?

Opportunity cost = 3.2 million Cash outlay = 14.3 million grading expense = 825k add all those up answer = 18.33 million because it is asking for the cash flow amount we need to add up the relevant information

Calculating Projected Net Income [LOl] A proposed new investment has pro jected sales of $515,000. Variable costs are 36 percent of sales, and fixed costs are $173,000; depreciation is $46,000. Prepare a pro forma income statement assuming a tax rate of 21 percent. What is the projected net income?

Sales = +515K -------------- Variable cost = -185400 (515k x .21) ----------------- Fixed costs = -173k ---------------------------- Depreciation = +46,000 ------------------------- EBT 110,600 (515K - 185K - 173K +46) ------------------------------------ Taxes = -23,226 (110,600 x .21) --------------------------------- Net income = 87,374 (110,600 - 23,226) Net income = 87,374

OCF from Several Approaches I LO 11 A proposed new project has projected sales of $215,000, costs of $ I04,000, and depreciation of $25,300. The tax rate is 23 percent. Calculate operating cash flow using the four different approaches described in the chapter and verify that the answer is the same in each case.

Sales = 215,000 Costs = -104,000 Depreciation = 25,300 ------------------------- EBIT = 136,300 Taxes = -28,623 ------------------ Net income = 107,677 OCF 136,300 (EBIT) - 28,623 (Taxes) + 25,300 (Depreciation) OCF = 132,977

Martin Enterprises needs someone to supply it with 115,000 cartons of machine screws per year to support its manufacturing needs over the next five years, and you've decided to bid on the contract. It will cost you $770,000 to install the equipment necessary to start production; you'll depreciate this cost straight-line to zero over the project's life. You estimate that, in five years, this equipment can be salvaged for $118,000. Your fixed production costs will be $385,000 per year, and your variable production costs should be $9.90 per carton. You also need an initial investment in net working capital of $65,000. If your tax rate is 21 percent and you require a return of 9 percent on your investment, what bid price should you submit? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Skip this one for now

Initial outlay

capital spending & change in NWC - change in net fixed assets - change in nwc OR filled in -140 -4 ------ initial cash flow = -144 Note that here we can simplify the "Capital Spending" cash flowcalculations to ∆NFA! If the project involves Capital Spending, the ∆NFAwill be positive.

net capital spending

change nfa - change in depreciation

Change in net working capital

current assets - current liabilities

project cash flow categories

initial outlay - present value of a cash flow annual cashflows = pmt terminal cash flows = future value

Delroy cash flow calculations

initial outlay = -144k CFs = 44.47k Terminal flow =34.5k PMT = 34.5K FV = 34.5K I/Y = 14 Because that was the required rate given N = 5 because that's the number of years of the CFs

Winnebagel Corp. currently sells 20,000 motor homes per year at $103,000 each and 14,000 luxury motor coaches per year at $155,000 each. The company wants to introduce a new portable camper to fill out its product line; it hopes to sell 25,000 of these campers per year at $19,000 each. An indepen dent consultant has determined that if the company introduces the new campers, it should boost the sales of its existing motor homes by 2,700 units per year and reduce the sales of its motor coaches by 1,300 units per year. What is the amount to use as the annual sales figure when evaluating this project? Why

motor homes 20k units sold up front they plan to increase motor homes by 2,700 so now the total number of motor homes = 22,700 motor coaches presently sold = 14,000 reduced by = -1,300 new number 12,700 New portable campers Projections = 25,000 25,500 + 22,700 + 12,700 = 60,400

Net capital spending

net fixed assets (end) - net fixed assets (beg) + depreciation