Presentation on theme: "Capital Budgeting Problems"— Presentation transcript:
1 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.OCF=NI + Depreciation=11, ,175=18,170.5OCF=Sales-Costs-Tax=49,350-25,000-6,179.5=18,170.5OCF= (Sales-Costs)(1-T)+ Depreciation T=(49,350-25,000)(1-0.34)+ 6,=18,170.5OCF= (Sales-Costs- Depreciation)(1-T)+ Depreciation=(Sales-Costs)(1-T)+ Depreciation TTax=(Sales-Costs- Depreciation) TOCF= Sales-Costs-(Sales-Costs- Depreciation) T
2 Capital Budgeting Problems 8. Calculating Salvage Value Consider an asset that costs$100,000 and is 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 $20,000. If the relevant tax rate is 35 percent, what is the after-tax cashflow from the sale of this asset?BV5=37,500SV5=20,000T=35%NSV=SV5-(SV5-BV5) T=20,000-(20,000-37,500) 0.35=26,125
3 Capital Budgeting Problems 24. Cost-Cutting Proposals Rosello’s Machine Shop isconsidering 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 themodified ACRS five-year class life, and has a salvage value at theend of the project of $50,000. The press also requires an initialinvestment in spare parts inventory of $15,000, along with anadditional $5,000 in inventory for each succeeding year of theproject. If the shop’s tax rate is 34 percent and its discount rate is13 percent, should Rosello’s buy and install the machine press.
4 Capital Budgeting Problems CS0=200, year MACRSCost=-85,000NWC0=15,000NWC=5,000 for 1-3T=34%k=13%NSV4=SV4-(SV4-BV4) T=50,000-(50,000-34,560) 0.34=44,750.4
6 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:The eradication system will require $875,000 in net working capitalto start, and additional net working capital investments each yearequal to 35 percent of the projected sales increase for thefollowing 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.
7 Capital Budgeting Problems The equipment needed to begin production has an installed cost of$9,750,000. This equipment is mostly industrial machinery andthus qualifies as seven-year modified ACRS property. In five years,this equipment can be sold for about 28 percent of its acquisitioncost. TPC is in the 38 percent marginal tax bracket and has arequired return on all of its projects of 10 percent. Based on thesepreliminary project estimates, what is the NPV of the project? Whatis the IRR?
11 Capital Budgeting Problems Replacement Project Topsider, Inc. is considering the purchaseof a new leather-cutting machine to replace an existing machinewhich it purchased 2 years ago at a price of $10,000. The oldmachine had an expected life of 5 years at the time it was purchased andis being depreciated straight-line to zero. It can be sold for $5,000today. The replacement decision has no effect on net working capitalrequirement. The new machine will reduce costs (before taxes) by $7,000per year. The new machine has a 3-year life, it costs $14,000, and can besold for an expected $2,000 at the end of the third year. The new machinewould be depreciated using the ACRS method. Assume a 40 percent taxrate. 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 theproject?
12 Capital Budgeting Problems SVnew=2,000BVnew=1,037.4NSVnew=2,000-(2,000-1,037.4) 0.4=1,614.96Cost=-7,000
14 Capital Budgeting Problems 30. Calculating Required Savings A proposed cost-savingdevice has an installed cost of $330,000. The device will be usedin a five-year project, but is classified as three-year modified ACRSproperty for tax purposes. The required initial net working capitalinvestment is $20,000, the marginal tax rate is 35 percent, and theproject discount rate is 12 percent. The device has an estimatedYear 5 salvage value of $45,000. What level of pretax cost savingsdo we require for this project to be profitable?
15 Capital Budgeting Problems 3 year MACRSNSV5=SV5-(SV5-BV5) T=45,000-(45,000-0) 0.35=29,250