FINA 3313 Ch.10

Which of the following changes, if of a sufficient magnitude, could turn a negative NPV project into a positive NPV project?

A decrease in the fixed costs

What is the amount of the operating cash flow for a firm with $378,585 profit before tax, $100,000 depreciation expense, and a 35% marginal tax rate?

$378,585*0.35= 132,504.75 378,585+100,000-132504.75= 346,080.25

Components of cash flow

1) Initial investment 2) Operating cash inflows 3)Terminal cash flow

What types of projects does the BNSF strategic studies team evaluate?

discretionary

What types of analyses do the BNSF strategic studies team conduct?

-discounted cash flow -sensitivity

A corporation is contemplating an expansion project. The CFO plans to calculate the project's NPV by discounting the relevant cash flows (which include the initial up-front costs, the operating cash flows, and the terminal cash flows) at the corporation's cost of capital (WACC). Which of the following factors should the CFO include when estimating the relevant cash flows?

-Any opportunity costs associated with the project.

***Jon Stevens, BNSF Vice President and Controller describes the capital spending process primarily as

-a means to ensure regulatory compliance -a balancing act that requires careful evaluation of the costs and benefits of each project

Identify which of these are the relevant cash flows when considering a capital budgeting project.

-lost rent from retail facility -remodeling expenses for new store -increase in inventory -expected salvage value of manufacturing equipment

Aero Motorcycles is considering opening a new manufacturing Fort Worth to meet the demand for a new line of solar-charged facility in motorcycles. The proposed project has the following features: • The firm just spent $300,000 for a marketing study to determine consumer demand (@t-0). • Aero Motorcycles purchased the land the factory will be built on 5 years ago for $2,000,000 and owns it outright (that is, it does not have a mortgage). The land has a current market value of $2,600,000 • The project has an initial cost of $ 20000000 excluding land, hint: the land is not subject to depreciation). • If the project is undertaken at t=0 the company will need to increase its inventories by $3,500,000, accounts receivable by $ 1500000 and its accounts payable by $2,000,000. This net operating working capital will be recovered at the end of the project's life (t = 10). • If the project is undertaken the company will realize an additional $8,000,000 in sales over each of the next ten years. (i.e. sales in each year are $8,000,000) • The company's operating cost (not including depreciation) will equal 50% of sales. • The company's tax rate is 35 percent. • Use a 10-year straight-line depreciation schedule. • At t = 10, the project is expected to cease being economically viable and the factory (including land) will be sold for $4,500,000 assume land has a book value equal to the original purchase price). • The project's WACC = 10 percent • Assume the firm is profitable and able to use any tax credits lie. negative taxes). What is the operating cash flow @t=1? Round to nearest whole dollar value

1) Project cost = 20,000,000 Salvage Value= 4,500,000-2,000,000= 2,500,000 Dep= (20,000,000-2,500,000)/10= 1,750,000 2) Revenue= 8,000,000 Cost= 50% of revenue= 4,000,000 EBITDA= Rev-cost= 4,000,000 Dep= 1,750,000 EBIT= EBITDA-Dep= 2,250,000 Tax= 35% of EBIT= 787,500 NOPAT= EBIT-Tax= 1,462,500 OCF= NOPAT+Dep= 3,212,500

Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet the demand for a new line of solar-charged motorcycles. The proposed project has the following features: • The firm just spent $300,000 for a marketing study to determine consumer demand (@t=0). • Aero Motorcycles purchased the land the factory will be built on 5 years ago for $2,000,000 and owns it outright (that is, it does not have a mortgage). The land has a current market value of $2,600,000. • The project has an initial cost of $ 20000000 excluding land, hint: the land is not subject to depreciation). • If the project is undertaken, at t=0 the company will need to increase its inventories by $3,500,000, accounts receivable by $ 1500000 and its accounts payable by $2,000,000. This net operating working capital will be recovered at the end of the project's life (t = 10). • If the project is undertaken, the company will realize an additional $8,000,000 in sales over each of the next ten years. (i.e. sales in each year are $8,000,000) • The company's operating cost (not including depreciation) will equal 50% of sales. • The company's tax rate is 35 percent. • Use a 10-year straight-line depreciation schedule. • At t = 10, the project is expected to cease being economically viable and the factory (including land) will be sold for $4500000 assume land has a book value equal to the original purchase price). • The project's WACC = 10 percent • Assume the firm is profitable and able to use any tax credits (ie. negative taxes) What is the operating cash flow @t=2? Round to nearest whole dollar value

1) Project cost = 20,000,000 Salvage Value= 4,500,000-2,000,000= 2,500,000 Dep= (20,000,000-2,500,000)/10= 1,750,000 2) Revenue= 8,000,000 Cost= 50% of revenue= 4,000,000 EBITDA= Rev-cost= 4,000,000 Dep= 1,750,000 EBIT= EBITDA-Dep= 2,250,000 Tax= 35% of EBIT= 787,500 NOPAT= EBIT-Tax= 1,462,500 OCF= NOPAT+Dep= 3,212,500

Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet the demand for a new line of solar-charged motorcycles​. The proposed project has the following​ features; ​• The firm just spent​ $300,000 for a marketing study to determine consumer demand​ (@ t=0). ​• Aero Motorcycles purchased the land the factory will be built on 5 years ago for​ $2,000,000 and owns it outright​ (that is, it does not have a​ mortgage). The land has a current market value of​ $2,600,000. ​• The project has an initial cost of​ $20,000,000 (excluding​ land, hint: the land is not subject to​ depreciation). ​• If the project is​ undertaken, at t​ = 0 the company will need to increase its inventories by​ $3,500,000, accounts receivable by​ $1,500,000, and its accounts payable by​ $2,000,000. This net operating working capital will be recovered at the end of the​ project's life​ (t =​ 10). ​• If the project is​ undertaken, the company will realize an additional​ $8,000,000 in sales over each of the next ten years.​ (i.e. sales in each year are​ $8,000,000) ​• The company's operating cost​ (not including​ depreciation) will equal​ 50% of sales. ​• The company's tax rate is 35 percent. ​• Use a​ 10-year straight-line depreciation schedule. ​• At t​ = 10, the project is expected to cease being economically viable and the factory​ (including land) will be sold for $4,500,000 (assume land has a book value equal to the original purchase​ price). ​• The project's WACC​ = 10 percent ​• Assume the firm is profitable and able to use any tax credits​ (i.e. negative​ taxes). What is the total cash flow at​ t=10? Round to nearest whole dollar value.

1) Project cost = 20,000,000 Salvage Value= 4,500,000-2,000,000= 2,500,000 Dep= (20,000,000-2,500,000)/10= 1,750,000 2) Revenue= 8,000,000 Cost= 50% of revenue= 4,000,000 EBITDA= Rev-cost= 4,000,000 Dep= 1,750,000 EBIT= EBITDA-Dep= 2,250,000 Tax= 35% of EBIT= 787,500 NOPAT= EBIT-Tax= 1,462,500 OCF= NOPAT+Dep= 3,212,500 3) NOWC= 3,500,000+1,500,000-2,000,000= 3,000,000 ATSV (from problem before)= 4,500,000 TCF= OCF+ATSV+ NOWC= 10,712,500

Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet the demand for a new line of solar-charged motorcycles (who wants to ride on a cloudy day anyway?) The proposed project has the following features; • The firm just spent $300,000 for a marketing study to determine consumer demand (@t=0). • Aero Motorcycles purchased the land the factory will be built on 5 years ago for $2,000,000 and owns it outright (that is, it does not have a mortgage). The land has a current market value of $2,600.000. • The project has an initial cost of $ 20000000 excluding land, hint: the land is not subject to depreciation). • If the project is undertaken, att=0 the company will need to increase its inventories by $3,500,000, accounts receivable by $ 1500000 and its accounts payable by $2,000,000. This net operating working capital will be recovered at the end of the project's life (t = 10). • If the project is undertaken, the company will realize an additional $8,000,000 in sales over each of the next ten years. (i.e. sales in each year are $8,000,000) • The company's operating cost (not including depreciation) will equal 50% of sales. • The company's tax rate is 35 percent. • Use a 10-year straight-line depreciation schedule. • Att= 10, the project is expected to cease being economically viable and the factory (including land) will be sold for $ 4500000 assume land has a book value equal to the original purchase price). • The project's WACC = 10 • Assume the firm is profitable and able to use any tax credits (i.e. negative taxes). What are the after tax proceeds from the sale of the factory (i.e..ATSV)? Round to nearest whole dollar value.

1) Project cost= 20,000,000 Dep= 1,750,000 2) Salvage Value= 4,500,000 BV Land= 2,000,000 Project= SV-Land= 2,500,000 BV project= Project Cost-(Yrs*Dep)= 2,500,000 BV Land + Project= 4,500,000 Tax gain= SV- BV Land & Project= 0 Taxes on gain= 35% * 0= 0 ATSV= SV- Taxes on gain= 4,500,000

***Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet the demand for a new line of solar-charged motorcycles (who wants to ride on a cloudy day anyway?) The proposed project has the following features: • The firm just spent $300,000 for a marketing study to determine consumer demand (@ t=0). • Aero Motorcycles purchased the land the factory will be built on 5 years ago for $2,000,000 and owns it outright (that is, it does not have a mortgage). The land has a current market value of $2,842,693. • The project has an initial cost of $ 20000000 excluding land, hint: the land is not subject to depreciation). • If the project is undertaken, at t=0 the company will need to increase its inventories by $3,500,000, accounts receivable by $ 1500000 and its accounts payable by $2,000,000. This net operating working capital will be recovered at the end of the project's life (t = 10). • If the project is undertaken, the company will realize an additional $8,000,000 in sales over each of the next ten years.(i.e. sales in each year are $8,000,000) • The company's operating cost (not including depreciation) will equal 50% of sales. • The company's tax rate is 35 percent. • Use a 10-year straight-line depreciation schedule. • At t= 10, the project is expected to cease being economically viable and the factory (including land) will be sold for $ 4500000 assume land has a book value equal to the original purchase price). • The project's WACC = 10 percent • Assume the firm is profitable and able to use any tax credits (ie negative taxes). What is the project's NPV?

1) Project= 20,000,000 Land (market value)= 2,842,693 NOWC (from problem before)= 3,000,000 CF0= Project+ Land+ NOWC= -25,842,693 2) CF0= -25,842,693 C01= 3,212,500 F01= 9 years C02= 10,712,500 F02= 1 I= 10% CPT NPV= -3,211,696.50

Aero Motorcycles is considering opening a new manufacturing facility in Fort Worth to meet demand for a new line of solar charged motorcycles (who wants to ride on a cloudy day anyway?) The proposed project has the following features: • The firm just spent $300,000 for marketing study to determine consumer demand (@t-0). • Aero Motorcycles purchased the land the factory will be built on 5 years ago for $2,000,000 and owns it outright (that is, it does not have a mortgage). The land has a current market value of $2,600,000. • The project has an initial cost of $ 22973784 excluding land, hint: land is not subject to depreciation), • If the project is undertaken, the company will realize an additional $8,000,000 in sales over each of the next ten years. (ie, sales in each year are $8,000,000) • The company's operating cost (not including depreciation) will equal 50% of sales. • The company's tax rate is 35 percent. • Use a 10-year straight-line depreciation schedule. • Att 10, the project is expected to cease being economically viable and the factory (including land) will be sold for $ 4500000 assume land has a book value equal to the original purchase price). • The project's WACC = 10 percent • Assume the firm is profitable and able to use any tax credits (ie. negative taxes).0 What is the project's outflow at t=0? Answer to the nearest whole dollar value.

2,600,000 +22,973,784 =25,573,784.00

***According to the article, "Sunk cost fallacy: Throwing good money after bad," how can banks limit losses from bad loans?

Increase bank executive turnover

A company just paid $10 million for a feasibility study. If the company goes ahead with the project, it must immediately spend another $100 million now, and then spend $20 million in one year. In two years it will receive $80 million, and in three years it will receive $90 million. If the cost of capital for the project is 11 percent, what is the project's IRR? % terms to 2 decimal places and without the % sign.

CF0= -100,000,000 C01= -20,000,000 F01= 1 C02= 80,000,000 F02= 1 C03= 90,000,000 CPT IRR= 15.95%

What is the equivalent annual cost for a project that requires a $50,000 investment at time-period zero, and a $10,000 annual expense during each of the next 4 years, if the opportunity cost of capital is 10%?

CF0=-50,000 CO1=-10,000 FO1=4 I=10% CPT NPV =-81,698.65 PV= -81,698.65 N=4 I=10 CPT PMT PMT=25,773.54

***A company just paid $10 million for a feasibility study. If the company goes ahead with the project, it must immediately spend another $84,391,290 million now, and then spend $20 million in one year. In two years it will receive $80 million, and in three years it will receive $90 million. If the cost of capital for the project is 11 percent, what is the project's NPV?

CFO=(-84,391,290) CO1=(-20,000,000) FO1=1 CO2= 80,000,000 FO2-1 CO3=90,000,000 FO3=1 I=11% CPT NPV= 28,327,710.96

***What is the net effect on a firm's working capital if a new project requires: $34,867 increase in inventory, $42,427 increase in accounts receivable, $35,000.00 increase in machinery, and a $42,993 increase in accounts payable? Round to nearest dollar amount.

Increase in Inventory: 34,867 Increase in A/R: 42,427 Increase in A/P: 42,993 34,867+42,427-42,993 =34,301

***If a 20% reduction in forecast sales would not extinguish a project's profitability, then sensitivity analysis would suggest:

Deemphasizing that variable as a critical factor.

Revenues generated by a new fad product are forecast as follows: Year: 1 Revenues: 44,359 Year:2 Revenues: 40,000 Year: 3 Revenues: 20,000 Year: 4 Revenues: 10,000 Thereafter 0 Expenses are expected to be 50% of revenues, and working capital required in each year is expected to be 20% of revenues in the following year. The product requires an Immediate Investment of $40,000 in plant and equipment that will be depreciated using the straight line method over 5 years. The firm recently spent $2.000 on a study to estimate the revenues of the new product. The tax rate is 20% What is the operating cash flow in year 17? Answer to nearest whole dollar amount.

Revenue: 44,359.00 -Expense: 22,179.50 (0.5*44,359) -Depreciation: 8,000.00 (40,000/5) =EBIT 14,179.50 -Tax 2,835.90 (0.2*14,179.50) =Net Income 11,343.60 (14,179.50-2,835.90) +Depreciation 8,000.00 =OCF 19,343.60 (11,343.60+8,000) Answer: 19343.60

Grill Master Johnnys is thinking about purchasing a new, energy-efficient grill. The grill will cost $53,000.00 and will be depreciated according to the 3-year MACRS schedule. It will be sold for scrap metal after 3 years for $11,750.00. The grill will have no effect on revenues but will save Johnny's $23,500.00 per year in energy expenses. The tax rate is 40%. The 3-year MACRS schedule: Year Depreciation % 1 33.33 2 44.45 3 14.81 4 7.41 What is the total cash flow in year 3?

Tax= 14.81% Initial investment:-53,000 Depreciation: YEAR 1 53,000*33.33%= $ 17,664.90 YEAR 2 53,000*44.45%= $ 23,558.50 YEAR 3 53,000*14.81%= $ 7,849.30 SV: 11,750 Revenue= 23,500.00 Dep = 7,849.30 EBIT = 15,650.70---(23,500-7,849.30) Tax = 6,260.28---(15,650.70*.40) NI= 9,390.42----(15,650.70-6,260.28) Dep $ 7,849.30 OCF$ 17,239.72---(9,390.42+ 7,849.30) BV= initial cost- accumulated depreciation BV=53,000-($17,664.90+$23,558.50+$7,849.30) BV= $ 3,927.30 ATSV=SV-tax*(SV-BV) ATSV=11,750-0.40*(11,750-3,927.30) ATSV= $ 8,620.92 Total Cash Flow= OCF+ATSV Total cash flow= 17,239.72+8,620.92 ANSWER= $ 25,860.64