Ch 8 Cash Flow
Riverton Sails is considering expanding its sail production operations to include awnings. The expansion would use land currently valued at $898,000 that was purchased for $779,000 cash. The expansion would require modifications costing $18,400 to some unused equipment along with the purchase of $314,800 of new equipment.The unused equipment is debt-free, fully depreciated, and has a market value of $27,900. What is the Time 0 cash flow for this expansion project?
$1,259,100 CF0 = $898,000 + $18,400 + $314,800 + $27,900 = $1,259,100
You purchased an asset 3 years ago at a cost of $135,000 and sold it today for $82,500. The equipment is 5-year property for MACRS. The MACRS table values are 0.2000, 0.3200, 0.1920, 0.1152, 0.1152, and 0.0576 for Years 1 to 6, respectively. Which one of the following statements is correct if the tax rate is 34 percent?
Current book value = $135,000 × (1 - 0.2 - 0.32 - 0.192) = $38,880 Taxable sale amount = $82,500 - $38,880 = $43,620 Tax = $43,620 × 0.34 = $14,830.80 After-tax salvage value = $82,500 - $14,830.80 = $67,669.20
The incremental cash flows of a project are best defined as
any change in a firm's cash flows resulting from the addition of the project including opportunity costs.
The cash flows of a new project that come at the expense of a firm's existing projects are called
erosion costs
The top-down approach to computing the operating cash flow
ignores all noncash items.
The pretax salvage value of an asset is equal to the
market value.
You spent $500 last week fixing the transmission in your car. Now, the brakes are acting up, and you are trying to decide whether to fix them or trade the car in for a newer model. In analyzing the brake situation, the $500 you spent fixing the transmission is a(n) _____ cost.
sunk
A project will produce an operating cash flow of $38,400 a year for 4 years. The initial cash outlay for equipment will be $57,300 and the net after-tax salvage value of $8,415 will be received at the end of the project. The project initially requires $1,200 of net working capital that will be fully recovered at project's end. What is the net present value of the project if the required rate of return is 16 percent?
NPV = −$57,300 − $1,200 + $38,400[(1 − 1 / 1.16^4) / 0.16] + ($8,415 + $1,200) / 1.16^4 = $54,260.42
Which one of the following will decrease a firm's net working capital?
A decrease in accounts receivable
Lefty's just purchased some equipment that is classified as 7-year property for MACRS. The equipment cost $123,940. The MACRS table values are 0.1429, 0.2449, 0.1749, 0.1249, and 0.0893, for Years 1 to 5, respectively. What will the book value of this equipment be at the end of 4 years?
Book value Year4 = $123,940 × ( 1 − 0.1429 − 0.2449 − 0.1749 − 0.1249)] = $38,718.86
Thornley Co. is considering a 3-year project with an initial cost of $636,000. The equipment is classified as MACRS 7-year property. The MACRS table values are 0.1429, 0.2449, 0.1749, 0.1249, 0.0893, 0.0892, 0.0893, and 0.0446 for Years 1 to 8, respectively. At the end of the project, the equipment will be sold for an estimated $279,000. The tax rate is 35 percent, and the required return is 17 percent. An extra $23,000 of inventory will be required for the life of the project. Annual sales are estimated at $379,000 with costs of $247,000. What is the total cash flow for Year 3?
Depreciation Year 3 = $636,000 × 0.1749 = $111,236.40 OCF3 = ($379,000 − $247,000)(0.65) + 0.35($11,236.40) = $124,732.74 Book ValueYear 3 = $636,000 × (1 − 0.1429 − 0.2449 − 0.1749) = $278,122.80 After-tax salvage value = $279,000 + (278,122.80 - 279,000)(0.35) = $278,692.98 C03 = $124,732.74 + 23,000 + 278,692.98 = $426,425.72
In project analysis, which one of these is a common assumption regarding net working capital?
Net working capital will be returned to its preproject level at the end of a project.
Ripley Co. is considering a project that will produce sales of $36,700 and increase cash expenses by $14,600. If the project is implemented, the firm's taxes will increase from $17,420 to $21,680 and depreciation will increase from $4,000 to $5,500. What is the amount of the operating cash flow using the top-down approach?
OCF = $36,700 − $14,600 − ($21,680 − $17,420) = $17,840
Peter's Boats has sales of $711,000 and a profit margin of 7.8 percent. The annual depreciation expense is $59,000. The tax rate is 35 percent. What is the amount of the operating cash flow if the company has no long-term debt?
OCF = ($711,000 × 0.078) + $59,000 = $114,458
Assume a machine costs $129,000 and lasts 3 years before it is replaced. The operating cost is $7,200 a year. Ignore taxes. What is the equivalent annual cost if the required rate of return is 14 percent?
PVCosts = $129,000 + $7,200[(1 − 1 / 1.14^3) / 0.14] = $145,715.75 $145,715.75 = EAC[(1 − 1 / 1.14^3) / 0.14] EAC = $62,764.36
Hill Motor Homes currently sells 1,160 Class A motor homes, 2,170 Class C motor homes, and 1,600 pop-up trailers each year. It is considering adding a midrange camper and expects that if it does so the firm can sell 800 of them. However, if the new camper is added, the firm expects its Class A sales to decline by 8 percent while the Class C camper sales decline to 1,950 units. The sales of pop-ups will not be affected. Class A motor homes sell for an average of $179,000 each. Class C homes are priced at $64,500, and the pop-ups sell for $5,700 each. The new midrange camper will sell for $26,900. What is the erosion cost of the new camper?
$30,801,200 Erosion cost = [0.08 × 1,160 × $179,000] + [(2,170 − 1,950) × $64,500] = $30,801,200
Farris Industrial purchased a machine 5 years ago at a cost of $229,380. The machine is being depreciated using the straight-line method over 8 years. The tax rate is 35 percent and the discount rate is 16 percent. If the machine is sold today for $74,500, what will be the after-tax salvage value?
$78,531.13 Book value = $229,380 − 5 × ($229,380 / 8) = $86,017.50 After-tax salvage value = $74,500 − 0.35 × ($74,500 − $86,017.50) = $78,531.13
Which one of these statements related to depreciation is correct for a firm with taxable income of $121,600 and after-tax income of $74,200?
Depreciation is a noncash expense that increases the firm's cash flows.
The Market is considering a project that will require the purchase of $1.27 million in new equipment. The equipment will be depreciated straight-line to zero over the 6-year life of the project. What is the value of the depreciation tax shield in Year 2 of the project if the tax rate is 35 percent?
Depreciation tax shield = ($1,270,000 / 6) × 0.35 = $74,083.33
Margarite's Enterprises is considering a new 5-year project that will require $612,000 for new fixed assets, $160,000 for inventory, and $35,000 for accounts receivable. Short-term debt is expected to increase by $110,000. The fixed assets will be depreciated straight-line to zero over the life of the project. The project is expected to generate annual sales of $694,000 with costs of $428,000. The tax rate is 35 percent, and the required rate of return is 15 percent. What is the amount of the earnings before interest and taxes (EBIT) for the first year of this project?
EBIT = $694,000 − $428,000 − ($612,000 / 5) = $143,600
A project will produce operating cash flows of $39,000 a year for 4 years. During the life of the project, inventory will be lowered by $9,000, accounts receivable will increase by $14,000, and accounts payable will increase by $11,000. The project requires $118,000 of new equipment that will be depreciated straight-line to a zero book value over 4 years. At the end of the project, net working capital will return to its normal level and the equipment will be sold for $21,000, aftertaxes. What is the net present value given a required return of 13 percent?
NWC requirement = $9,000 − $14,000 + $11,000 = $6,000 CF0 = $6,000 − $118,000 = −$112,000 C04, excluding OCF = −$6,000 + $21,000 = $15,000 NPV = −$112,000 + $39,000[(1 − 1 / 1.13^4) / 0.13] + $15,000 / 1.13^4 = $13,204.16
The Java House is considering a project that will produce sales of $59,280 and increase cash expenses by $26,040. If the project is implemented, taxes will increase by $4,600. The additional depreciation expense will be $10,100. An initial cash outlay of $7,300 is required for net working capital. What is the amount of the operating cash flow using the top-down approach?
OCF = $59,280 − $26,040 − $4,600 = $28,640
Kurt's Kabinets is looking at a 4-year project that will require $76,000 in fixed assets and another $20,000 in net working capital. Annual sales are projected at $142,800 with costs of $79,600. The company uses straight-line depreciation to a zero book value over the life of the project. The tax rate is 35 percent. What is the annual operating cash flow for this project?
OCF = ($142,800 − $79,600)(1 − 0.35) + ($76,000 / 4)(0.35) = $47,730
Ernie's Electrical is evaluating a project that will increase sales by $48,000 and costs by $16,000. The project will initially cost $89,000 for fixed assets that will be depreciated straight-line to a zero book value over the 6-year life of the project. The applicable tax rate is 34 percent. What is the project's annual operating cash flow?
OCF = ($48,000 − $16,000)(1 − 0.34) + ($89,000 / 6)(0.34) = $26,163.33
A project will increase sales by $92,800 and cash expenses by $53,200. The project will cost $89,000 and be depreciated using straight-line depreciation to a zero book value over the 4-year life of the project. The tax rate is 35 percent. What is the operating cash flow of the project using the tax shield approach?
OCF = [($92,800 − $53,200) × (1 − 0.35)] + [($89,000 / 4) × 0.35] = $33,527.50
JADO Mfg. is trying to decide which one of two machines to purchase. Machine A costs $398,000, has a 5-year life and requires $113,000 in pretax annual operating costs. Machine B costs $510,000, has a 4-year life and requires $67,000 in pretax annual operating costs. Either machine will be depreciated using the straight-line method to zero over its life. Neither machine will have any salvage value. Whichever machine is selected, it will never be replaced. The discount rate is 12 percent and the tax rate is 34 percent. Which machine should be purchased and why?
OCFA = −$113,000(1 − 0.34) + ($398,000 / 5)(0.34) = −$47,516 NPVA = −$398,000 − $47,516[(1 − 1 / 1.12^5) / 0.12] = −$569,284.55 OCFB =−$67,000(1 − 0.34) + ($510,000 / 4)(0.34) = −$870 NPVB = −$510,000 − $870[(1 − 1 / 1.124) /0.12] = −$512,642.49 DifferenceA −B = −$569,284.55 − (−$512,642.49) = −$56,642.06 Since the machine will not be replaced, Machine B should be purchased because it has the higher (less negative) NPV.
DeCento's is analyzing two mutually exclusive machines to determine which one it should purchase. Whichever machine is purchased, it will be replaced at the end of its useful life. The company requires a return of 15 percent and uses straight-line depreciation to a zero book value over the life of the machine. Machine A has a cost of $386,000, annual operating costs of $29,000, and life of 4 years. Machine B costs $257,000, has annual operating costs of $19,000, and a life of 3 years. The firm currently pays no taxes. Which machine should be purchased and why?
PVCost, A = $386,000 + $29,000[(1 − 1 / 1.15^4) / 0.15] = $468,794.37 $468,794.37 = EAC[(1 − 1 / 1.15^4) / 0.15]EAC = $164,202.43 PVCost, B = $257,000 + $19,000[(1 − 1 / 1.15^3) / 0.15] = $300,381.28 $300,318.28 = EAC[(1 − 1 / 1.15^3) / 0.15] EAC = $131,560.08 Difference in EAC(A-B) = $164,202.43 − $131,560.08 = $32,642.35 Machine B has the lower equivalent annual cost, so it should be purchased.
The initial cost of a machine is $727,000 with annual operating costs of $39,600. Each machine has a life of 5 years before it is replaced. Ignore taxes. What is the equivalent annual cost of this machine if the required return is 16 percent?
PVCosts = $727,000 + $39,600[(1 − 1 / 1.16^5) / 0.16] = $856,662.03 $856,662.03 = EAC[(1 − 1 / 1.16^5) / 0.16] EAC = $261,632.62
A project is expected to create operating cash flows of $37,600 a year for 3 years. The initial cost of the fixed assets is $98,000. These assets will be worthless at the end of the project. Also, $3,200 of net working capital will be required throughout the life of the project. What is the project's net present value if the required rate of return is 14 percent?
−$11,746.73 NPV = −$98,000 − $3,200 + $37,600[(1 − 1 / 1.143) / 0.14] + $3,200 / 1.143 = −$11,746.73