Transcript Tentative Outline - Bilkent University

Capital Budgeting Problems
6. OCF from Several Approaches A proposed new project has projected
sales of $49,350, costs of $25,000, and depreciation of $6,175. The tax rate is
34 percent. Calculate operating cash flow using three different approaches
and verify that the answer is the same in each case.
Sales
Costs
Depreciation
EBIT
Tax
Net Income
49,350
25,000
6,175
18,175
6,179.5
11,995.5
OCF=NI + Depreciation=11,995.5+6,175=18,170.5
OCF=Sales-Costs-Tax=49,350-25,000-6,179.5=18,170.5
OCF= (Sales-Costs)(1-T)+ Depreciation T=(49,350-25,000)(1-0.34)+ 6,175 0.34
=18,170.5
OCF= (Sales-Costs- Depreciation)(1-T)+ Depreciation
=(Sales-Costs)(1-T)+ Depreciation T
Tax=(Sales-Costs- Depreciation) T
OCF= Sales-Costs-(Sales-Costs- Depreciation) T
=(Sales-Costs)(1-T)+ Depreciation T
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Capital Budgeting Problems
8. Calculating Salvage Value Consider an asset that costs
$100,000 and is depreciated straight-line to zero over its eightyear 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 $20,000. If the
relevant tax rate is 35 percent, what is the after-tax cashflow from
the sale of this asset?
D=
100 ,000  0
=12,500
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BV5=37,500
SV5=20,000
T=35%
NSV=SV5-(SV5-BV5) T=20,000-(20,000-37,500) 0.35=26,125
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Capital Budgeting Problems
24. Cost-Cutting Proposals Rosello’s Machine Shop is
considering a four-year project to improve its production efficiency.
Buying a new machine press for $200,000 is estimated to produce
$85,000 in annual pretax cost savings. The press falls in the
modified ACRS five-year class life, and has a salvage value at the
end of the project of $50,000. The press also requires an initial
investment in spare parts inventory of $15,000, along with an
additional $5,000 in inventory for each succeeding year of the
project. If the shop’s tax rate is 34 percent and its discount rate is
13 percent, should Rosello’s buy and install the machine press.
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Capital Budgeting Problems
CS0=200,000
5 year MACRS
Year Depreciation(%) Depreciation($) Depreciation T
Cost=-85,000
1
20.00
40,000
13,600
2
32.00
64,000
21,760
NWC0=15,000
3
19.20
38,400
13,056
4
11.52
23,040
7,833.6
NWC=5,000 for 1-3
5
11.52
23,040
7,833.6
6
5.76
11,520
3,916.8
T=34%
k=13%
NSV4=SV4-(SV4-BV4) T=50,000-(50,000-34,560) 0.34=44,750.4
Year
1
2
3
4
-Cost(1-T)
85,000 0.66
85,000 0.66
85,000 0.66
85,000 0.66
DT
13,600
21,760
13,056
7,833.6
OCF
69,700
77,860
69,156
63,933.6
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Capital Budgeting Problems
CS
NWC
OCF
FCF
0
-200,000
-15,000
-215,000
NPV=-215,000+
1
2
3
-5,000
-5,000
4
44,750.4
-5,000
30,000
69,700
77,860
69,156
63,933.6
64,700
72,860
64,156
138,684
64,700 72,860 64 ,156 138 ,684
+
+
+
=28,837.55
1.13
1.13 2
1.13 3
1.13 4
.
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Capital Budgeting Problems
29. Expansion Project Terminator Pest Control (TPC), Inc., projects
unit sales for a new household-use laser-guided cockroach eradication
system as follows:
Year
1
2
3
4
5
Unit Sales
80,000
90,000
95,000
99,000
75,000
The eradication system will require $875,000 in net working capital
to start, and additional net working capital investments each year
equal to 35 percent of the projected sales increase for the
following year.(Since sales are expected to fall in Year 5 then,
there is no NWC cash flow occuring for Year 4.) Total fixed costs are
$200,000 per year, variable production costs are $75 per unit, and the
units are priced at $105 each.
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Capital Budgeting Problems
The equipment needed to begin production has an installed cost of
$9,750,000. This equipment is mostly industrial machinery and
thus qualifies as seven-year modified ACRS property. In five years,
this equipment can be sold for about 28 percent of its acquisition
cost. TPC is in the 38 percent marginal tax bracket and has a
required return on all of its projects of 10 percent. Based on these
preliminary project estimates, what is the NPV of the project? What
is the IRR?
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Capital Budgeting Problems
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Capital Budgeting Problems
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Capital Budgeting Problems
NPV=723,567.96
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Capital Budgeting Problems
Replacement Project Topsider, Inc. is considering the purchase
of a new leather-cutting machine to replace an existing machine
which it purchased 2 years ago at a price of $10,000. The old
machine had an expected life of 5 years at the time it was purchased and
is being depreciated straight-line to zero. It can be sold for $5,000
today. The replacement decision has no effect on net working capital
requirement. The new machine will reduce costs (before taxes) by $7,000
per year. The new machine has a 3-year life, it costs $14,000, and can be
sold for an expected $2,000 at the end of the third year. The new machine
would be depreciated using the ACRS method. Assume a 40 percent tax
rate. The firm has a required return on all of its projects of 12 percent.
Based on these preliminary project estimates, what is the NPV of the
project?
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Capital Budgeting Problems
SVnew=2,000
BVnew=1,037.4
NSVnew=2,000-(2,000-1,037.4) 0.4=1,614.96
Cost=-7,000
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Capital Budgeting Problems
NPV=3,956.87
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Capital Budgeting Problems
30. Calculating Required Savings A proposed cost-saving
device has an installed cost of $330,000. The device will be used
in a five-year project, but is classified as three-year modified ACRS
property for tax purposes. The required initial net working capital
investment is $20,000, the marginal tax rate is 35 percent, and the
project discount rate is 12 percent. The device has an estimated
Year 5 salvage value of $45,000. What level of pretax cost savings
do we require for this project to be profitable?
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Capital Budgeting Problems
3 year MACRS
Year
1
2
3
4
Depreciation(%) Depreciation($) Depreciation T
33.33
109,989
38,496.15
44.44
146,652
51,328.2
14.82
48,906
17,117.1
7.41
24,453
8,558.55
NSV5=SV5-(SV5-BV5) T=45,000-(45,000-0) 0.35=29,250
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Capital Budgeting Problems
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