FIN222 Summer2015 Lectures Lecture 4

Slide 1

10-1

Making Capital Investment Decisions

Chapter 10Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin110-2Chapter OutlineCapital Budgeting and Cash FlowsIncremental Cash FlowsPro Forma Financial StatementsOperating Cash FlowsSpecial Cases of DCF AnalysisCost Cutting

10-3Capital Budgeting and Cash FlowsIn the previous chapter we focused on multiple techniques of capital budgeting to evaluate projects.

This chapter is all about how each of the cash flows (CFs) are determined.

10-4Project Example - VisualR = 12%$ -165,000123CF1 = 63,120CF2 = 70,800CF3 = 91,080The required return for assets of this risk level is 12% (as determined by the firm).410-5Relevant Cash FlowsThe cash flows that should be included in a capital budgeting analysis are those that will only occur (or not occur) if the project is acceptedCash flows that will occur whether or not we accept a project are NOT relevant.

These cash flows are called incremental cash flows

The stand-alone principle allows us to analyze each project in isolation from the firm simply by focusing on incremental cash flows

510-6Asking the Right QuestionYou should always ask yourself: Will this cash flow occur ONLY IF we accept the project?

If the answer is yes, it should be included in the analysis because it is incremental

If the answer is no, it should not be included in the analysis because it will occur anyway

If the answer is part of it, then we should include the part that occurs because of the project610-7Common Types of Cash FlowsSunk costs costs that have accrued in the past: Should they be included?

Opportunity costs costs of lost options

Changes in net working capital (NWC)Assumed to be recovered at the end of the projects lifeFinancing costs: Generally not included

Taxes710-8Common Types of Cash Flows6. Side effects:

Positive side effects benefits to other projects

Negative side effects (erosion) costs to other projects89Pro Forma Statements and Cash FlowCapital budgeting relies heavily on pro forma accounting statements, particularly income statementsComputing Net Cash Flows (NCFs):1. Initial Cash Outlay = Project Cost + Change in NWC2. Operating Cash Flows (OCFs)Tax Shield Approach:OCF = (Sales - Costs) (1 - T) + Depreciation * T (OCF = EBIT + Depreciation Taxes)3. Terminal Cash Flow = Salvage Value Taxes + Recovery of NWC

9.9Operating cash flow students often have to go back to the income statement to see that the two definitions of operating cash flow are equivalent when there is no interest expense.

10-10Pro Forma Statements and Cash FlowCF Definitions (MUST KNOW AT ALL TIMES):

Operating Cash Flow (OCF)= EBIT + depreciation taxesOCF = NI + Dep. (when there is no interest expense)Cash Flow From Assets (CFFA) = OCF net capital spending (NCS) changes in NWC (NWC)1010-11MUST KNOW AT ALL TIMESMost common financial calculation for OCF is: OCF = EBIT + Depreciation Taxes

The top-down approach to calculating OCF yields:OCF = Sales Costs Taxes Do not subtract non-cash deductionsThe tax-shield approach is:OCF = (Sales Costs).(1 tC) + tC . Depreciation

The bottom-up approach is:OCF = Net income + Depreciation All four methods for OCF should always give same answer. Different Ways to Compute OCFs11Example: Pb. 5 Ch.10Most common financial calculation for OCF:OCF = EBIT + Depreciation Taxes OCF = $50,200 + 6,800 17,570 = $39,430Top-down approach:OCF = Sales Costs Taxes (Depreciation is NOT deducted here)OCF = $108,000 51,000 17,570 = $39,430Tax-shield approach:OCF = (Sales Costs)(1 T) + T.Dep. OCF = ($108,000 51,000)(1 .35) + .35(6,800) = $39,430Bottom-up approach :OCF = NI + Dep. OCF = $32,630 + 6,800 = $39,430

10-13Getting Started: The ProjectYou have been thinking about starting a new project to produce mobile phone plastic cases. Your business plan can be summarized as follows:You estimate you can sell 50,000 pieces @ $4 each. Production cost is $2.5 per unit. Project is expected to have a life a three years. The machine needed would cost $90,000 and will be fully depreciated over the life of the project.Fixed costs (for rent of production facility and other) are estimated at $12,000The project is expected to require an initial investment in net working capital of $20,000.Similar projects offer a 20% rate of returnTax rate on income =34%1310-14Getting Started: Project Pro Forma Income Statement

OCF = EBIT + Dep - Tax = 51,780.00

1410-15Projected Total Cash Flows+ Purchase price of the new asset Selling price of the asset replaced (if applicable)+ Costs of site preparation, setup, and startup+(-) Increase (decrease) in tax liability due to sale of old asset at other than book value

Capital spending at the time of project inception (i.e., the initial outlay) includes following items:NCS =OCF NWC NCS =CFFA

9.1510-16Project Example - VisualR = 20%$ -110,000123CF1 = 51,780CF2 = 51,780CF3 = 71,780The required return for assets of this risk level is 20% (as determined by the firm).1610-17Whats Your Decision?

So...What do you think? Deal or No Deal?

1710-18More on NWCWhy do we have to consider changes in NWC separately?GAAP requires that sales be recorded on the income statement when made, not when the cash is received.GAAP also requires that we record the cost of goods sold when the corresponding sales are made, whether we have actually paid our suppliers to date.Finally, we have to buy inventory to support sales, although we havent collected cash yet.9.1810-19DepreciationThe depreciation expense used for capital budgeting should be the depreciation schedule required by the IRS for tax purposes

Depreciation itself is a non-cash expense; consequently, it is only relevant because it affects taxes

Calculation:

Where D is depreciation expense and T is marginal tax rate of the firmDepreciation tax shield = D.T1910-20Computing DepreciationStraight-line depreciationD = (Initial cost salvage) / number of yearsVery few assets are depreciated using the straight-line method for tax purposesMACRSTo compute depreciation expense: First need to know which asset class is appropriate for tax purposesMultiply percentage given in table by the initial costDepreciate to zero9.2010-21After-tax SalvageIf the salvage(market) value is different from the book value of the asset, then there is a tax effect

CF to consider is AT Salvage:

Book Value = Initial cost accumulated depreciationAfter-tax salvage = Salvage T*(Salvage BV@ time of sale)10-22After-tax Salvage ComputationMarket Value Book Value = gain (or loss)

Take gain (or loss) x (marginal tax rate)

Pay taxes on a gain; Receive a tax benefit on a loss

After-tax Salvage =Market Value taxes paid or Market Value + tax benefit2210-23Example: Depreciation and After-tax Salvage You purchase equipment for $100,000, and it costs $10,000 to have it delivered and installed.

Based on past information, you believe that you can sell the equipment for $17,000 when you are done with it in 6 years. 10-24Example: Depreciation and After-tax Salvage The companys marginal tax rate is 40%. What is the depreciation expense and the after-tax salvage (AT-Salvage) in year 6 for each of the following three scenarios?Straight line Depreciation MACRS 3-yearsMACRS 6 years$ -110,0006Sell = $17,0005432102410-25A: Straight-lineD = (110,000 17,000) / 6 = 15,500 every year for 6 years

BV in year 6 = 110,000 6(15,500) = 17,000

AT-Salvage = 17,000 - 0.4.(17,000 17,000) = 17,000Book Value = Initial cost accumulated depreciationAfter-tax salvage = Salvage T*(Salvage BV@ time of sale)2510-26A: Straight-Line The companys marginal tax rate is 40%. Market Selling Price = $17,000Book Value at year 6= $17,000Capital gain/loss = 0

Taxes paid on gain/loss = ($0).40 = $0

After-tax salvage value: 17,000 - .40 (17,000 17,000) = $17,000After-tax salvage = Salvage T*(Salvage BV@ time of sale)2610-27B: 3-year MACRSYearMACRS percentDepreciation per year1.3333.3333.(110,000) Dep1= $36,6632.4445.4445.(110,000) Dep2= $48,8953.1481.1481.(110,000) Dep3= $16,2914.0741.0741.(110,000) Dep4= $8,1519.2710-28B: 3-Year MACRS The companys marginal tax rate is 40%. Market Selling Price = $17,000Book Value at year 6: $ 0Capital gain/loss = $17,000

Taxes paid on gain/loss = ($17,000).40 = $ 6,800AT salvage value: 17,000 - .40 (17,000 0) = $10,200After-tax salvage = Salvage T*(Salvage BV@ time of sale)2810-29C: 7-Year MACRSYearMACRS PercentDepreciation Per year1.1429.1429(110,000) = D1=$15,7192.2449.2449(110,000) = D2=$26,9393.1749.1749(110,000) = D3=$19,2394.1249.1249(110,000) = D4=$13,7395.0893.0893(110,000) = D5= $ 9,8236.0892.0892(110,000) = D6= $ 9,8122910-30C: 7-year MACRS The companys marginal tax rate is 40%. Market Selling Price = $17,000Book Value at year 6 = $14,729Capital gain /loss = $ 2,271

Taxes paid on gain/loss = $2,271x40% = $908.40After-tax salvage value: 17,000 - .40 (17,000 14,729) = $16,091.60After-tax salvage = Salvage T*(Salvage BV@ time of sale)3010-31Example: Cost Cutting Your company is considering a new computer system with initial cost =$1 million. It will generate $300,000 per year cost savings. System expected to last for 5 years and will be depreciated using 3-year MACRS. System expected to have a salvage value of $50,000 at the end of year5. There is no impact on NWC. The marginal tax rate is 40%. The required return is 8%.9.3110-32Cost Cutting - AnalysisInitial Cost1,000,000Savings300,000Tax Rate40%Expected Salvage50,000Discount Rate8%

10-33Comprehensive Problem A $1,000,000 investment is depreciated using a seven-year MACRS class life. It requires $150,000 in additional inventory and will increase accounts payable by $50,000. It will generate $400,000 in revenue and $150,000 in cash expenses annually, and the tax rate is 40%. What is the incremental cash flow in years 0, 1, 7, and 8?

1.3310-34Formulas Operating Cash Flow (OCF) = EBIT + depreciation taxes

OCF = Net income + depreciation (when there is no interest expense)

Cash Flow From Assets (CFFA) = OCF net capital spending (NCS) changes in NW

After-tax salvage = salvage T (salvage book value at time of sale)10-35Formulas (continued) Operating Cash Flow Formula:

Bottom-Up ApproachOCF = NI + depreciation

Top-Down ApproachOCF = Sales Costs Taxes

Tax Shield ApproachOCF = (Sales Costs)(1 T) + Depreciation*T10-36The cash flows for a project are computed using incremental cash flows considering depreciation and after-tax salvage values. Straight-line and MACRS methods of depreciation are used to compute the depreciation of an asset.Cash Flows From Assets (CFFA) computes the annual cash flows for capital budgeting purposes.What are the most important topics of this chapter?

36Chapter 10

Chapter 10

Problems 1-36

Input boxes in tanOutput boxes in yellowGiven data in blueCalculations in redAnswers in green

NOTE: Some functions used in these spreadsheets may require that the "Analysis ToolPak" or "Solver Add-In" be installed in Excel.To install these, click on the Office button then "Excel Options," "Add-Ins" and select"Go." Check "Analyis ToolPak" and "Solver Add-In," then click "OK."

#1Chapter 10Question 1

Input area:

Purchase price$6,000,000Appraised value$6,400,000Cost to build$14,200,000Grading costs$890,000

Total initial cost$21,490,000Output area:

The acquisition cost is a sunk cost. The appraisal value is an opportunity cost and should be included. The cost to build and grading costs are investments in fixed assets and are included.

Total initial cost$21,490,000


Input area:

Motor home price$68,000Motor coach price$105,000Camper quantity25,000Camper price$14,000Increased motor home quantity2,400Lost motor coach quantity1,100

Output area:

Camper sales$350,000,000Increased motor home sales163,200,000Lost motor coach sales(115,500,000)Total sales $397,700,000


Input area:

Projected sales$750,000Variable cost (% of sales)55%Fixed cost$164,000Depreciation$65,000Tax rate35%

Output area:

Sales $750,000Variable costs412,500Fixed costs164,000Depreciation65,000EBT$108,500Taxes (35%)37,975Net Income$70,525


Input area:

Sales824,500Variable cost538,900Depreciation126,500Tax rate34%

Output area:

Sales $824,500Variable costs538,900Depreciation126,500EBT$159,100Taxes (34%)54,094Net Income$105,006

OCF$231,506Depreciation tax shield$43,010


Input area:

Projected sales$108,000Costs$51,000Depreciation$6,800Tax rate35%

Output area:

Sales 108,000Variable costs51,000Depreciation6,800EBT50,200Taxes (35%)17,570Net Income32,630

EBIT50,200

OCF39,430OCF = EBIT + Dep Taxes $39,430OCF39,430OCF = Sales Costs Taxes $39,430 (Depreciation is NOT deducted here)OCF39,430OCF = (Sales Costs)(1 T) + T.Dep39,430OCF39,430OCF = NI + Dep$39,430


Input area:

Costs$975,000*7-year property under MACRS

Output area:

Yr.Beginning Book ValueMACRSDepreciationEnding Book value1$975,000.000.1429$139,327.50$835,672.502835,672.500.2449238,777.50596,895.003596,895.000.1749170,527.50426,367.504426,367.500.1249121,777.50304,590.005304,590.000.089387,067.50217,522.506217,522.500.089286,970.00130,552.507130,552.500.089387,067.5043,485.00843,485.000.044643,485.000.0


Input area:

Costs$640,000Pretax salvage value$175,000Tax rate35%*Depreciation straight line8*Asset used in years5

Output area:

Annual depreciation$80,000Accumulated depreciation$400,000Book value$240,000

Aftertax cash flow$197,750


Input area:

Acquisition costs$6,100,000Pretax salvage value$1,300,000Tax rate35%*MACRS class for taxes0.20000.32000.19200.1152

Output area:

Book Value$1,054,080

Aftertax cash flow$1,213,928


Input area:

Asset investment$2,700,000Estimated annual sales$2,080,000Costs$775,000Tax rate35%*Depreciation straight-lineto zero over tax life3

Output area:

OCF$1,163,250


Input area:

Asset investment$2,700,000Estimated annual sales$2,080,000Costs$775,000Tax rate35%*Depreciation straight-lineto zero over tax life3OCF$1,163,250Required return12%

Output area:

NPV$93,930.22


Input area:

Asset investment$2,700,000Estimated annual sales$2,080,000Costs$775,000Tax rate35%Required return12%*Depreciation straight-lineto zero over tax life3OCF$1,163,250Initial investment in NWC$300,000Fixed asset value at end $210,000

Output area:

YearCash flow0$(3,000,000)1$1,163,2502$1,163,2503$1,599,750

NPV$104,622.30


Input area:

Asset investment$2,700,000Estimated annual sales$2,080,000Costs$775,000Tax rate35%Required return12%Initial investment in NWC$300,000Fixed asset value at end $210,000*3 yr MACRS 0.33330.44450.1481

Output area:

YearDepreciationCash flow0$(3,000,000.00)1$899,910.00$1,163,218.502$1,200,150.00$1,268,302.503$399,870.00$1,494,729.00

Book value$200,070

Aftertax salvage value$206,525

NPV$113,589.51


Input area:

Installation cost$480,000Pretax salvage value$70,000Operating cost per year$160,000Initial NWC$29,000Tax rate34%Discount rate10%*Depreciation straight-lineover life5

Output area:

Annual depreciation charge$96,000Aftertax salvage value$46,200OCF$138,240

NPV$61,731.65


Input area:

Initial investment$580,000Pretax salvage value$60,000Cost savings per year$210,000Working capital reduction$(75,000)Tax rate35%*Depreciation straight-lineover life5

Output area:


YearCash flow0$(505,000)1$177,1002$177,1003$177,1004$177,1005$141,100

IRR20.94%


Input area:

Initial investment$580,000Pretax salvage value$60,000Cost savings per year$200,000 Cost savings per year$150,000Working capital reduction$(75,000)Annual depreciation charge$116,000Aftertax salvage value$39,000Tax rate35%Required return15%*Depreciation straight-lineover life5

Output area:

$200,000cost savings$150,000cost savingsYearCash flowYearCash flow0$(505,000)0$(505,000)1170,6001138,1002170,6002138,1003170,6003138,1004170,6004138,1005134,6005102,100NPV$48,979.30$(59,965.74)Accept/RejectAcceptReject

Required pretax cost savings:NPV w/o OCF($522,898.36)Required OCF$155,988.71OCF less dep. tax shield$115,388.71

Cost savings$177,521.10


Input area:

Initial fixed asset investment$310,000Initial NWC investment$30,000Annual OCF$(29,000)Required return11%*Depreciation staight-lineover life5

Output area:

NPV$(429,377.47)

EAC$(116,176.80)


Input area:

Techron I :Cost$240,000Operating costs per year$63,000Life3Techron II :Cost$420,000Operating costs per year$36,000Life5Both:Salvage value$40,000Tax rate35%Discount rate10%*Depreciation straight-line

Output area:

Both cases:Aftertax salvage value$26,000.00Techron I:OCF$(12,950.00)NPV$(252,670.55)EAC$(101,602.57)Techron II:OCF$6,000.00NPV$(381,111.32)EAC$(100,536.21)

The two milling machines have unequal lives, so they can only be compared by expressing both on an equivalent annual basis which is what the EAC method does.Thus, you prefer the Techron IIbecause it has the lower(less negative) annual cost.


Input area:

Quantity120,000Installation costs$870,000Pretax salvage value$70,000Fixed costs$325,000Variable production cost per carton$10.30Net working capital$75,000Tax rate35%Required return12%*Depreciation staight-lineover life5

Output area:

Aftertax salvage value$45,500.00Depreciation tax shield$60,900.00Initial cash outlay$(945,000.00)NPV w/o OCF$(876,625.06)Necessary OCF$243,184.32OCF net of dep. tax shield$182,284.32

Bid price$15.35


Input area:

Machine cost$470,000Annual pretax cost$190,000Salvage value$80,000Inventory cost$20,000Inventory cost per year$2,500Tax rate35%Discount rate9%MACRS five year class0.20000.32000.19200.1152

Output area:

YearDepreciation1$94,0002$150,4003$90,2404$54,144

Book value$81,216.00Aftertax salvage value$80,425.60

YearCash flow without NWC1$156,400.002$176,140.003$155,084.004$142,450.40

YearCash flow0$(490,000.00)1$153,900.002$173,640.003$152,584.004$250,376.00

NPV$92,537.49


Input area:

System A:Cost $240,000Pretax annual operating cost$75,000Life4System B:Cost $340,000Pretax annual operating cost$69,000Life6Both:Tax rate34%Discount rate8%*Depreciation staight-line

Output area:

System A:OCF$(29,100)NPV$(336,382.89)System B:OCF$(26,273)NPV$(461,458.46)

If the system will not be replaced when it wearsout, then System Ashould be chosen, because it has the morepositive NPV.


Input area:

System A:NPV$(336,382.89)Operating life4System B:NPV$(461,458.46)Operating life6

Discount rate8%

Output area:

System A:EAC$(101,560.99)System B:EAC$(99,820.56)

If the system is replaced, System Bshould be chosen because it has the lower EAC.


Input area:

Quantity100,000,000Initial land cost$1,900,000Land opportunity cost$2,100,000Land value in 5 years$2,300,000Machine cost$5,400,000Pretax salvage value$500,000Fixed costs$1,050,000Variable cost$0.005Initial NWC$600,000Additional NWC/year$50,000Tax rate34%Required return12%*Depreciation staight-lineover life5

Output area:

Aftertax salvage value$330,000.00Depreciation tax shield$367,200.00Initial cash outlay$(8,100,000.00)NPV w/o OCF$(6,305,593.35)Necessary OCF$1,749,232.96OCF net of dep. tax shield$1,382,032.96

Bid price$0.03644


Output area:

At a given price, taking accelerated depreciation compared to straight-linedepreciation causes the NPV to be higher; similarly at a given price, lower net working capital investment requirements will cause the NPV to be higher. Thus,NPV would be zero at a lower price in this situation. In the case of a bid price, you could submit a lower price and still breakeven, or submit the higher priceand make a positive NPV.


Input area:

Machine A:Cost $3,100,000Variable costs35%Fixed costs$240,000Life6Machine B:Cost $5,300,000Variable costs30%Fixed costs$175,000Life9Both:Sales$11,000,000Tax rate35%Discount rate10%*Depreciation staight-line

Output area:

Machine AMachine BVariable costs$(3,850,000)$(3,300,000)Fixed costs(240,000)(175,000)Depreciation(516,667)(588,889)EBT$(4,606,667)$(4,063,889)Tax1,612,3331,422,361Net income$(2,994,333)$(2,641,528)+ Dep516,667588,889OCF$(2,477,667)$(2,052,639)

NPV$(13,890,884.26)$(17,121,196.25)EAC$(3,189,449.55)$(2,972,933.75)

Machine Bshould be chosen since it has the lower EAC.

#25Chapter 10Question 25Input area:

Hours used per year500Cost per kilowatt$0.121Return10%

Traditional bulbCFLCost$0.45$3.40Watts6015Lifetime hours1,00012,000

Output area:

Kilowatts used per hour0.060.015Kilowatt hours per year307.50Cost per year$3.6300$0.9075Expected life224.00

NPV$(6.75)$(11.55)EAC$(3.8893)$(1.2859)




Output area:

Kilowatts used per hour0.0600.015Kilowatt hours per year30.007.50Cost per year$3.6300$0.9075Expected life2.0024.00

Breakeven kilowatt/hr cost$0.005295



Traditional bulbCFLCost$0.45$3.40Watts6015Lifetime hours50012,000

Output area:


Breakeven kilowatt/hr cost$(0.005181)


Car mpg25Truck mpg10New car mpg40New truck mpg12.5Gas price$3.70Miles per year12,000

Output area:

Gallons used per year Current car480.00 New car300.00 Current truck1,200.00 New truck960.00

Gallons saved New car180.00 New truck240.00


Input area:

Original cost of land$1,400,000Current land value$1,500,000Land value in 4 years$1,600,000Marketing study$125,000Year 1 sales3,800Year 2 sales4,700Year 3 sales5,300Year 4 sales4,200Sales price$650Fixed costs$425,000Variable costs15%Equipment costs$3,500,000Pretax salvage value$400,000Net working capital$125,000Tax rate38%Required return13%Year 1 depreciation33.33%Year 2 depreciation44.45%Year 3 depreciation14.81%Year 4 depreciation7.41%

Output area:

Aftertax salvage valueSale price$400,000Taxes(152,000)Total$248,000

Year 0Year 1Year 2Year 3Year 4Revenues$2,470,000$3,055,000$3,445,000$2,730,000Fixed costs425,000425,000425,000425,000Variable costs370,500458,250516,750409,500Depreciation1,166,5501,555,750518,350259,350EBT$507,950$616,000$1,984,900$1,636,150Taxes193,021234,080754,262621,737Net income$314,929$381,920$1,230,638$1,014,413OCF$1,481,479$1,937,670$1,748,988$1,273,763

Capital spending$(3,500,000)$248,000Land(1,500,000)1,600,000Net working capital(125,000)125,000

Total cash flow$(5,125,000)$1,481,479$1,937,670$1,748,988$3,246,763

NPV$906,960.17


Input area:

Year 1 unit sales81,000Year 2 unit sales94,000Year 3 unit sales108,000Year 4 unit sales103,000Year 5 unit sales84,000Initial NWC$1,600,000Additional NWC/year15%Fixed costs$1,500,000Variable cost per unit$265Unit price$380Equipment cost$21,000,000Salvage value (% of price)20%Tax rate35%Required return18%MACRS depreciation14.29%24.49%17.49%12.49%8.93%

Output area:

Year012345Ending book value$17,999,100$12,856,200$9,183,300$6,560,400$4,685,100

Sales$30,780,000$35,720,000$41,040,000$39,140,000$31,920,000Variable costs21,465,00024,910,00028,620,00027,295,00022,260,000Fixed costs1,500,0001,500,0001,500,0001,500,0001,500,000Depreciation3,000,9005,142,9003,672,9002,622,9001,875,300EBIT$4,814,100$4,167,100$7,247,100$7,722,100$6,284,700Taxes1,684,9351,458,4852,536,4852,702,7352,199,645Net income$3,129,165$2,708,615$4,710,615$5,019,365$4,085,055Depreciation3,000,9005,142,9003,672,9002,622,9001,875,300Operating cash flow$6,130,065$7,851,515$8,383,515$7,642,265$5,960,355

Net cash flowsOperating cash flow0.0$6,130,065$7,851,515$8,383,515$7,642,265$5,960,355Change in NWC(1,600,000)(741,000)(798,000)285,0001,083,0001,771,000Capital spending(21,000,000)0.00.00.00.04,369,785Total cash flow$(22,600,000)$5,389,065$7,053,515$8,668,515$8,725,265$12,101,140

Net present value$2,098,569.18Internal rate of return21.54%


Input area:

Installed cost$730,000Salvage value$80,000Initial NWC$55,000Tax rate35%Required return9%MACRS33.33%44.45%14.81%7.41%

Output area:

Aftertax salvage value$52,000.00

Year 1 depreciation $243,309.00Year 2 depreciation $324,485.00Year 3 depreciation $108,113.00Year 4 depreciation $54,093.00

Year 1 depreciation CF$85,158.15Year 2 depreciation CF$113,569.75Year 3 depreciation CF$37,839.55Year 4 depreciation CF$18,932.55Initial cash outlay$(785,000.00)NPV net of OCF$(499,109.84)

Pretax cost savings$197,411.35


Input area:

Quantity120,000Installation costs$870,000Pretax salvage value$70,000Fixed costs$325,000Variable production cost per carton$10.30Net working capital$75,000Tax rate35%Required return12%*Depreciation straight-lineover life5Price per carton$17.00

Output area:


a.Year012345Sales$2,040,000$2,040,000$2,040,000$2,040,000$2,040,000Variable costs1,236,0001,236,0001,236,0001,236,0001,236,000Fixed costs325,000325,000325,000325,000325,000Depreciation174,000174,000174,000174,000174,000EBIT$305,000$305,000$305,000$305,000$305,000Taxes106,750106,750106,750106,750106,750Net income$198,250$198,250$198,250$198,250$198,250Depreciation174,000174,000174,000174,000174,000Operating cash flow$372,250$372,250$372,250$372,250$372,250

Net cash flowsOperating cash flow0.0$372,250$372,250$372,250$372,250$372,250Change in NWC(75,000)0.00.00.00.075,000Capital spending(870,000)0.00.00.00.045,500Total cash flow$(945,000)$372,250$372,250$372,250$372,250$492,750

Net present value$465,252.88

b.NPV w/o OCF$(876,625.06)Necessary OCF$243,184.32Breakeven quantity90,364

Year012345Sales$1,536,185$1,536,185$1,536,185$1,536,185$1,536,185Variable costs930,747930,747930,747930,747930,747Fixed costs325,000325,000325,000325,000325,000Depreciation174,000174,000174,000174,000174,000EBIT$106,437$106,437$106,437$106,437$106,437Taxes37,25337,25337,25337,25337,253Net income$69,184$69,184$69,184$69,184$69,184Depreciation174,000174,000174,000174,000174,000Operating cash flow$243,184$243,184$243,184$243,184$243,184


Net present value0.0

c.NPV w/o OCF$(876,625.06)Necessary OCF$243,184.32Breakeven fixed costs$523,562.58

Year012345Sales$2,040,000$2,040,000$2,040,000$2,040,000$2,040,000Variable costs1,236,0001,236,0001,236,0001,236,0001,236,000Fixed costs523,563523,563523,563523,563523,563Depreciation174,000174,000174,000174,000174,000EBIT$106,437$106,437$106,437$106,437$106,437Taxes37,25337,25337,25337,25337,253Net income$69,184$69,184$69,184$69,184$69,184Depreciation174,000174,000174,000174,000174,000Operating cash flow$243,184$243,184$243,184$243,184$243,184




Input area:

Contract quantity4,200Equipment$3,800,000Net working capital$95,000Salvage value$275,000Fixed costs$640,000Variable costs/unit$155Mkt. sales in Year 19,500Mkt. sales in Year 210,400Mkt. sales in Year 312,500Mkt. sales in Year 49,800Market price$310Tax rate40%Required return10%Project NPV$100,000

Output area:

Market sales1234Sales$2,945,000$3,224,000$3,875,000$3,038,000Variable costs1,472,5001,612,0001,937,5001,519,000EBT$1,472,500$1,612,000$1,937,500$1,519,000Tax589,000644,800775,000607,600Net income (and OCF)$883,500$967,200$1,162,500$911,400

NPV of market sales$3,098,422.58Initial investment$3,895,000Aftertax salvage value$165,000

NPV of OCF$718,993.92OCF$226,821.59

Bid price$246.60


Input Area:

Old cost$1,300,000New machine cost$1,560,000Life of machine5Salvage value$300,000Old machine depreciation$260,000Old machine life left3MV old machine$420,000Old machine value in 2 yrs$120,000Saved operating costs$290,000Discount rate12%Tax rate38%

Output Area:

a.New computer:Year012345Ending book value$1,560,000$1,248,000$936,000$624,000$312,0000.0

Cost savings$179,800$179,800$179,800$179,800$179,800Depreciation$118,560$118,560$118,560$118,560$118,560Operating CF$298,360$298,360$298,360$298,360$298,360

Change in NWC000000Capital spending$(1,560,000)0000$186,000Total cash flow$(1,560,000)$298,360$298,360$298,360$298,360$484,360

Net present value$(378,937.58)EAC$(105,120.97)

Old Computer:Year012345Ending book value$520,000$260,000

Depreciation tax shield$98,800$98,800Change in NWC000Capital spending$(556,800)0$173,200Total cash flow$(556,800)$98,800$272,000


b.Difference:New computer$(1,560,000)$298,360$298,360$298,360$298,360$484,360Old computer$556,800($98,800)$(272,000)0.00.00.0Total cash flow$(1,003,200)$199,560$26,360$298,360$298,360$484,360

NPV$(127,188.60)

Chapter 10

Chapter 10

Problems 1-36

Input boxes in tanOutput boxes in yellowGiven data in blueCalculations in redAnswers in green

NOTE: Some functions used in these spreadsheets may require that the "Analysis ToolPak" or "Solver Add-In" be installed in Excel.To install these, click on the Office button then "Excel Options," "Add-Ins" and select"Go." Check "Analyis ToolPak" and "Solver Add-In," then click "OK."


Input area:

Purchase price$6,000,000Appraised value$6,400,000Cost to build$14,200,000Grading costs$890,000

Total initial cost$21,490,000Output area:

The acquisition cost is a sunk cost. The appraisal value is an opportunity cost and should be included. The cost to build and grading costs are investments in fixed assets and are included.

Total initial cost$21,490,000


Input area:

Motor home price$68,000Motor coach price$105,000Camper quantity25,000Camper price$14,000Increased motor home quantity2,400Lost motor coach quantity1,100

Output area:

Camper sales$350,000,000Increased motor home sales163,200,000Lost motor coach sales(115,500,000)Total sales $397,700,000


Input area:

Projected sales$750,000Variable cost (% of sales)55%Fixed cost$164,000Depreciation$65,000Tax rate35%

Output area:

Sales $750,000Variable costs412,500Fixed costs164,000Depreciation65,000EBT$108,500Taxes (35%)37,975Net Income$70,525


Input area:

Sales824,500Variable cost538,900Depreciation126,500Tax rate34%

Output area:

Sales $824,500Variable costs538,900Depreciation126,500EBT$159,100Taxes (34%)54,094Net Income$105,006

OCF$231,506Depreciation tax shield$43,010


Input area:

Projected sales$108,000Costs$51,000Depreciation$6,800Tax rate35%

Output area:

Sales 108,000Variable costs51,000Depreciation6,800EBIT50,200Taxes (35%)17,570Net Income32,630

EBIT50,200

OCF39,430OCF = EBIT + Dep Taxes $39,430OCF39,430OCF = Sales Costs Taxes $39,430 (Depreciation is NOT deducted here)OCF39,430OCF = (Sales Costs)(1 T) + T.Dep39,430OCF39,430OCF = NI + Dep$39,430


Input area:

Costs$975,000*7-year property under MACRS

Output area:

Yr.Beginning Book ValueMACRSDepreciationEnding Book value1$975,000.000.1429$139,327.50$835,672.502835,672.500.2449238,777.50596,895.003596,895.000.1749170,527.50426,367.504426,367.500.1249121,777.50304,590.005304,590.000.089387,067.50217,522.506217,522.500.089286,970.00130,552.507130,552.500.089387,067.5043,485.00843,485.000.044643,485.000.0


Input area:

Costs$640,000Pretax salvage value$175,000Tax rate35%*Depreciation straight line8*Asset used in years5

Output area:

Annual depreciation$80,000Accumulated depreciation$400,000Book value$240,000

Aftertax cash flow$197,750


Input area:

Acquisition costs$6,100,000Pretax salvage value$1,300,000Tax rate35%*MACRS class for taxes0.20000.32000.19200.1152

Output area:

Book Value$1,054,080

Aftertax cash flow$1,213,928


Input area:

Asset investment$2,700,000Estimated annual sales$2,080,000Costs$775,000Tax rate35%*Depreciation straight-lineto zero over tax life3

Output area:

OCF$1,163,250


Input area:

Asset investment$2,700,000Estimated annual sales$2,080,000Costs$775,000Tax rate35%*Depreciation straight-lineto zero over tax life3OCF$1,163,250Required return12%

Output area:

NPV$93,930.22


Input area:

Asset investment$2,700,000Estimated annual sales$2,080,000Costs$775,000Tax rate35%Required return12%*Depreciation straight-lineto zero over tax life3OCF$1,163,250Initial investment in NWC$300,000Fixed asset value at end $210,000

Output area:

YearCash flow0$(3,000,000)1$1,163,2502$1,163,2503$1,599,750

NPV$104,622.30


Input area:

Asset investment$2,700,000Estimated annual sales$2,080,000Costs$775,000Tax rate35%Required return12%Initial investment in NWC$300,000Fixed asset value at end $210,000*3 yr MACRS 0.33330.44450.1481

Output area:

YearDepreciationCash flow0$(3,000,000.00)1$899,910.00$1,163,218.502$1,200,150.00$1,268,302.503$399,870.00$1,494,729.00

Book value$200,070


NPV$113,589.51


Input area:

Installation cost$480,000Pretax salvage value$70,000Operating cost per year$160,000Initial NWC$29,000Tax rate34%Discount rate10%*Depreciation straight-lineover life5

Output area:


NPV$61,731.65


Input area:

Initial investment$580,000Pretax salvage value$60,000Cost savings per year$210,000Working capital reduction$(75,000)Tax rate35%*Depreciation straight-lineover life5

Output area:


YearCash flow0$(505,000)1$177,1002$177,1003$177,1004$177,1005$141,100

IRR20.94%


Input area:

Initial investment$580,000Pretax salvage value$60,000Cost savings per year$200,000 Cost savings per year$150,000Working capital reduction$(75,000)Annual depreciation charge$116,000Aftertax salvage value$39,000Tax rate35%Required return15%*Depreciation straight-lineover life5

Output area:

$200,000cost savings$150,000cost savingsYearCash flowYearCash flow0$(505,000)0$(505,000)1170,6001138,1002170,6002138,1003170,6003138,1004170,6004138,1005134,6005102,100NPV$48,979.30$(59,965.74)Accept/RejectAcceptReject

Required pretax cost savings:NPV w/o OCF($522,898.36)Required OCF$155,988.71OCF less dep. tax shield$115,388.71

Cost savings$177,521.10


Input area:

Initial fixed asset investment$310,000Initial NWC investment$30,000Annual OCF$(29,000)Required return11%*Depreciation staight-lineover life5

Output area:

NPV$(429,377.47)

EAC$(116,176.80)


Input area:

Techron I :Cost$240,000Operating costs per year$63,000Life3Techron II :Cost$420,000Operating costs per year$36,000Life5Both:Salvage value$40,000Tax rate35%Discount rate10%*Depreciation straight-line

Output area:

Both cases:Aftertax salvage value$26,000.00Techron I:OCF$(12,950.00)NPV$(252,670.55)EAC$(101,602.57)Techron II:OCF$6,000.00NPV$(381,111.32)EAC$(100,536.21)

The two milling machines have unequal lives, so they can only be compared by expressing both on an equivalent annual basis which is what the EAC method does.Thus, you prefer the Techron IIbecause it has the lower(less negative) annual cost.


Input area:

Quantity120,000Installation costs$870,000Pretax salvage value$70,000Fixed costs$325,000Variable production cost per carton$10.30Net working capital$75,000Tax rate35%Required return12%*Depreciation staight-lineover life5

Output area:

Aftertax salvage value$45,500.00Depreciation tax shield$60,900.00Initial cash outlay$(945,000.00)NPV w/o OCF$(876,625.06)Necessary OCF$243,184.32OCF net of dep. tax shield$182,284.32

Bid price$15.35


Input area:

Machine cost$470,000Annual pretax cost$190,000Salvage value$80,000Inventory cost$20,000Inventory cost per year$2,500Tax rate35%Discount rate9%MACRS five year class0.20000.32000.19200.1152

Output area:

YearDepreciation1$94,0002$150,4003$90,2404$54,144

Book value$81,216.00Aftertax salvage value$80,425.60

YearCash flow without NWC1$156,400.002$176,140.003$155,084.004$142,450.40

YearCash flow0$(490,000.00)1$153,900.002$173,640.003$152,584.004$250,376.00

NPV$92,537.49


Input area:

System A:Cost $240,000Pretax annual operating cost$75,000Life4System B:Cost $340,000Pretax annual operating cost$69,000Life6Both:Tax rate34%Discount rate8%*Depreciation staight-line

Output area:

System A:OCF$(29,100)NPV$(336,382.89)System B:OCF$(26,273)NPV$(461,458.46)

If the system will not be replaced when it wearsout, then System Ashould be chosen, because it has the morepositive NPV.


Input area:

System A:NPV$(336,382.89)Operating life4System B:NPV$(461,458.46)Operating life6

Discount rate8%

Output area:

System A:EAC$(101,560.99)System B:EAC$(99,820.56)

If the system is replaced, System Bshould be chosen because it has the lower EAC.


Input area:

Quantity100,000,000Initial land cost$1,900,000Land opportunity cost$2,100,000Land value in 5 years$2,300,000Machine cost$5,400,000Pretax salvage value$500,000Fixed costs$1,050,000Variable cost$0.005Initial NWC$600,000Additional NWC/year$50,000Tax rate34%Required return12%*Depreciation staight-lineover life5

Output area:

Aftertax salvage value$330,000.00Depreciation tax shield$367,200.00Initial cash outlay$(8,100,000.00)NPV w/o OCF$(6,305,593.35)Necessary OCF$1,749,232.96OCF net of dep. tax shield$1,382,032.96

Bid price$0.03644


Output area:

At a given price, taking accelerated depreciation compared to straight-linedepreciation causes the NPV to be higher; similarly at a given price, lower net working capital investment requirements will cause the NPV to be higher. Thus,NPV would be zero at a lower price in this situation. In the case of a bid price, you could submit a lower price and still breakeven, or submit the higher priceand make a positive NPV.


Input area:

Machine A:Cost $3,100,000Variable costs35%Fixed costs$240,000Life6Machine B:Cost $5,300,000Variable costs30%Fixed costs$175,000Life9Both:Sales$11,000,000Tax rate35%Discount rate10%*Depreciation staight-line

Output area:

Machine AMachine BVariable costs$(3,850,000)$(3,300,000)Fixed costs(240,000)(175,000)Depreciation(516,667)(588,889)EBT$(4,606,667)$(4,063,889)Tax1,612,3331,422,361Net income$(2,994,333)$(2,641,528)+ Dep516,667588,889OCF$(2,477,667)$(2,052,639)

NPV$(13,890,884.26)$(17,121,196.25)EAC$(3,189,449.55)$(2,972,933.75)

Machine Bshould be chosen since it has the lower EAC.




Output area:

Kilowatts used per hour0.060.015Kilowatt hours per year307.50Cost per year$3.6300$0.9075Expected life224.00

NPV$(6.75)$(11.55)EAC$(3.8893)$(1.2859)




Output area:


Breakeven kilowatt/hr cost$0.005295



Traditional bulbCFLCost$0.45$3.40Watts6015Lifetime hours50012,000

Output area:


Breakeven kilowatt/hr cost$(0.005181)


Car mpg25Truck mpg10New car mpg40New truck mpg12.5Gas price$3.70Miles per year12,000

Output area:

Gallons used per year Current car480.00 New car300.00 Current truck1,200.00 New truck960.00

Gallons saved New car180.00 New truck240.00


Input area:

Original cost of land$1,400,000Current land value$1,500,000Land value in 4 years$1,600,000Marketing study$125,000Year 1 sales3,800Year 2 sales4,700Year 3 sales5,300Year 4 sales4,200Sales price$650Fixed costs$425,000Variable costs15%Equipment costs$3,500,000Pretax salvage value$400,000Net working capital$125,000Tax rate38%Required return13%Year 1 depreciation33.33%Year 2 depreciation44.45%Year 3 depreciation14.81%Year 4 depreciation7.41%

Output area:

Aftertax salvage valueSale price$400,000Taxes(152,000)Total$248,000

Year 0Year 1Year 2Year 3Year 4Revenues$2,470,000$3,055,000$3,445,000$2,730,000Fixed costs425,000425,000425,000425,000Variable costs370,500458,250516,750409,500Depreciation1,166,5501,555,750518,350259,350EBT$507,950$616,000$1,984,900$1,636,150Taxes193,021234,080754,262621,737Net income$314,929$381,920$1,230,638$1,014,413OCF$1,481,479$1,937,670$1,748,988$1,273,763

Capital spending$(3,500,000)$248,000Land(1,500,000)1,600,000Net working capital(125,000)125,000

Total cash flow$(5,125,000)$1,481,479$1,937,670$1,748,988$3,246,763

NPV$906,960.17


Input area:

Year 1 unit sales81,000Year 2 unit sales94,000Year 3 unit sales108,000Year 4 unit sales103,000Year 5 unit sales84,000Initial NWC$1,600,000Additional NWC/year15%Fixed costs$1,500,000Variable cost per unit$265Unit price$380Equipment cost$21,000,000Salvage value (% of price)20%Tax rate35%Required return18%MACRS depreciation14.29%24.49%17.49%12.49%8.93%

Output area:

Year012345Ending book value$17,999,100$12,856,200$9,183,300$6,560,400$4,685,100

Sales$30,780,000$35,720,000$41,040,000$39,140,000$31,920,000Variable costs21,465,00024,910,00028,620,00027,295,00022,260,000Fixed costs1,500,0001,500,0001,500,0001,500,0001,500,000Depreciation3,000,9005,142,9003,672,9002,622,9001,875,300EBIT$4,814,100$4,167,100$7,247,100$7,722,100$6,284,700Taxes1,684,9351,458,4852,536,4852,702,7352,199,645Net income$3,129,165$2,708,615$4,710,615$5,019,365$4,085,055Depreciation3,000,9005,142,9003,672,9002,622,9001,875,300Operating cash flow$6,130,065$7,851,515$8,383,515$7,642,265$5,960,355

Net cash flowsOperating cash flow0.0$6,130,065$7,851,515$8,383,515$7,642,265$5,960,355Change in NWC(1,600,000)(741,000)(798,000)285,0001,083,0001,771,000Capital spending(21,000,000)0.00.00.00.04,369,785Total cash flow$(22,600,000)$5,389,065$7,053,515$8,668,515$8,725,265$12,101,140

Net present value$2,098,569.18Internal rate of return21.54%


Input area:

Installed cost$730,000Salvage value$80,000Initial NWC$55,000Tax rate35%Required return9%MACRS33.33%44.45%14.81%7.41%

Output area:

Aftertax salvage value$52,000.00

Year 1 depreciation $243,309.00Year 2 depreciation $324,485.00Year 3 depreciation $108,113.00Year 4 depreciation $54,093.00

Year 1 depreciation CF$85,158.15Year 2 depreciation CF$113,569.75Year 3 depreciation CF$37,839.55Year 4 depreciation CF$18,932.55Initial cash outlay$(785,000.00)NPV net of OCF$(499,109.84)

Pretax cost savings$197,411.35


Input area:

Quantity120,000Installation costs$870,000Pretax salvage value$70,000Fixed costs$325,000Variable production cost per carton$10.30Net working capital$75,000Tax rate35%Required return12%*Depreciation straight-lineover life5Price per carton$17.00

Output area:


a.Year012345Sales$2,040,000$2,040,000$2,040,000$2,040,000$2,040,000Variable costs1,236,0001,236,0001,236,0001,236,0001,236,000Fixed costs325,000325,000325,000325,000325,000Depreciation174,000174,000174,000174,000174,000EBIT$305,000$305,000$305,000$305,000$305,000Taxes106,750106,750106,750106,750106,750Net income$198,250$198,250$198,250$198,250$198,250Depreciation174,000174,000174,000174,000174,000Operating cash flow$372,250$372,250$372,250$372,250$372,250


Net present value$465,252.88

b.NPV w/o OCF$(876,625.06)Necessary OCF$243,184.32Breakeven quantity90,364

Year012345Sales$1,536,185$1,536,185$1,536,185$1,536,185$1,536,185Variable costs930,747930,747930,747930,747930,747Fixed costs325,000325,000325,000325,000325,000Depreciation174,000174,000174,000174,000174,000EBIT$106,437$106,437$106,437$106,437$106,437Taxes37,25337,25337,25337,25337,253Net income$69,184$69,184$69,184$69,184$69,184Depreciation174,000174,000174,000174,000174,000Operating cash flow$243,184$243,184$243,184$243,184$243,184



c.NPV w/o OCF$(876,625.06)Necessary OCF$243,184.32Breakeven fixed costs$523,562.58

Year012345Sales$2,040,000$2,040,000$2,040,000$2,040,000$2,040,000Variable costs1,236,0001,236,0001,236,0001,236,0001,236,000Fixed costs523,563523,563523,563523,563523,563Depreciation174,000174,000174,000174,000174,000EBIT$106,437$106,437$106,437$106,437$106,437Taxes37,25337,25337,25337,25337,253Net income$69,184$69,184$69,184$69,184$69,184Depreciation174,000174,000174,000174,000174,000Operating cash flow$243,184$243,184$243,184$243,184$243,184




Input area:

Contract quantity4,200Equipment$3,800,000Net working capital$95,000Salvage value$275,000Fixed costs$640,000Variable costs/unit$155Mkt. sales in Year 19,500Mkt. sales in Year 210,400Mkt. sales in Year 312,500Mkt. sales in Year 49,800Market price$310Tax rate40%Required return10%Project NPV$100,000

Output area:

Market sales1234Sales$2,945,000$3,224,000$3,875,000$3,038,000Variable costs1,472,5001,612,0001,937,5001,519,000EBT$1,472,500$1,612,000$1,937,500$1,519,000Tax589,000644,800775,000607,600Net income (and OCF)$883,500$967,200$1,162,500$911,400

NPV of market sales$3,098,422.58Initial investment$3,895,000Aftertax salvage value$165,000

NPV of OCF$718,993.92OCF$226,821.59

Bid price$246.60


Input Area:

Old cost$1,300,000New machine cost$1,560,000Life of machine5Salvage value$300,000Old machine depreciation$260,000Old machine life left3MV old machine$420,000Old machine value in 2 yrs$120,000Saved operating costs$290,000Discount rate12%Tax rate38%

Output Area:

a.New computer:Year012345Ending book value$1,560,000$1,248,000$936,000$624,000$312,0000.0

Cost savings$179,800$179,800$179,800$179,800$179,800Depreciation$118,560$118,560$118,560$118,560$118,560Operating CF$298,360$298,360$298,360$298,360$298,360

Change in NWC000000Capital spending$(1,560,000)0000$186,000Total cash flow$(1,560,000)$298,360$298,360$298,360$298,360$484,360


Old Computer:Year012345Ending book value$520,000$260,000

Depreciation tax shield$98,800$98,800Change in NWC000Capital spending$(556,800)0$173,200Total cash flow$(556,800)$98,800$272,000


b.Difference:New computer$(1,560,000)$298,360$298,360$298,360$298,360$484,360Old computer$556,800($98,800)$(272,000)0.00.00.0Total cash flow$(1,003,200)$199,560$26,360$298,360$298,360$484,360

NPV$(127,188.60)

Sheet1

Sales (50,000 units at $4.00/unit)$200,000Variable Costs ($2.50/unit)125,000Gross profit$75,000Fixed costs12,000Depreciation ($90,000 /3)30,000EBIT$33,000Taxes (34%)11,220Net Income$21,780

INPUT DataProforma Income StatementQ50,000.00Sales200,000.00P4Variable Costs125,000.00vc2.5Gross profit75,000.00N3Fixed costs12,000.00FC12,000.00Depreciation30,000.00Cost of the Machine90,000.00EBIT33,000.00T34%Taxes (34%)11,220.00Net Income21,780.00OCF=51,780.00

Sheet2

Sheet3

Sheet1

Sales (50,000 units at $4.00/unit)$200,000Variable Costs ($2.50/unit)125,000Gross profit$75,000Fixed costs12,000Depreciation ($90,000 /3)30,000EBIT$33,000Taxes (34%)11,220Net Income$21,780

INPUT DataProforma Income StatementQ50,000.00Sales200,000.00P4Variable Costs125,000.00vc2.5Gross profit75,000.00N3Fixed costs12,000.00FC12,000.00Depreciation30,000.00Cost of the Machine90,000.00EBIT33,000.00T34%Taxes (34%)11,220.00Net Income21,780.00OCF=51,780.00

Sheet2

Sheet3

Sheet1Sales (50,000 units at $4.00/unit)$200,000Variable Costs ($2.50/unit)125,000Gross profit$75,000Fixed costs12,000Depreciation ($90,000 /3)30,000EBIT$33,000Taxes (34%)11,220Net Income$21,780

INPUT DataProforma Income StatementQ50,000.00Sales200,000.00P4Variable Costs125,000.00vc2.5Gross profit75,000.00N3Fixed costs12,000.00FC12,000.00Depreciation30,000.00Cost of the Machine90,000.00EBIT33,000.00T34%Taxes (34%)11,220.00Net Income21,780.00OCF = NI + Dep51,780.00OCF = EBIT + Dep - Tax = 51,780.00

110000YearMACRS percent10.333336663.0020.444548895.0030.148116291.0040.07418151.00110000.00

Year0123OCF$51,780$51,780$51,780NWC($20,000)0020,000Net CS($90,000) =CFFA-$110,00$51,780$51,780$71,780

Sheet2

Sheet3


INPUT DataProforma Income StatementQ50,000.00Sales200,000.00P4Variable Costs125,000.00vc2.5Gross profit75,000.00N3Fixed costs12,000.00FC12,000.00Depreciation30,000.00Cost of the Machine90,000.00EBIT33,000.00T34%Taxes (34%)11,220.00Net Income21,780.00OCF = NI + Dep51,780.00OCF = EBIT + Dep - Tax = 51,780.00

110000YearMACRS percent10.333336663.0020.444548895.0030.148116291.0040.07418151.00110000.00

Year0123OCF$51,780$51,780$51,780NWC($20,000)0020,000Net CS($90,000) =CFFA-$110,00$51,780$51,780$71,780

Sheet2

Sheet3


INPUT DataProforma Income StatementQ50,000.00Sales200,000.00P4Variable Costs125,000.00vc2.5Gross profit75,000.00N3Fixed costs12,000.00FC12,000.00Depreciation30,000.00Cost of the Machine90,000.00EBIT33,000.00T34%Taxes (34%)11,220.00Net Income21,780.00OCF = NI + Dep51,780.00OCF = EBIT + Dep - Tax = 51,780.00110000YearMACRS percent10.333336663.0020.444548895.0030.148116291.0040.07418151.00110000.00

Year0123OCF$51,780$51,780$51,780NWC($20,000)0020,000Net CS($90,000) CFFA-$110,00$51,780$51,780$71,780110000YearMACRS PercentDepreciation Per year10.14291571920.24492693930.17491923940.12491373950.0893982360.0892981295271Ending BV = 14729AT Salvage =16091.6

Sheet2

Year12345Cost Savings50,00050,00050,00050,00050,000Depr. New49,99566,67522,21511,1150 Old9,0009,0009,0009,0009,000Increm.Depr40,99557,67513,2152,115-9,000EBIT9,005-7,67536,78547,88559,000Taxes3,602-3,07014,71419,15423,600NI5,403-4,60522,07128,73135,400OCF46,39853,07035,28630,84626,400150000YearMACRS %Deprec.10.333349,995.0020.444566,675.0030.148122,215.0040.074111,115.00500.0

Year012345OCF46,39853,07035,28630,84626,400NCS-89,000-10,000DNWC00CFFA-89,00046,39853,07035,28630,84616,400NPV= 54,801.74IRR =36.28%

Sheet3Old MachineInitial cost 100,000Annual depreciation 9,000Purchased 5 years agoBook Value 55,000Salvage today 65,000Salvage in 5 years 10,000

New MachineInitial cost 150,000Life5yearsSalvage in 5 years 0Cost savings 50,000a year3-year MACRS depreciation

SolutionsInitial Cost1,000,000Savings300,000Tax Rate40%Expected Salvage50,000Discount Rate8%

MACRS Depreciation ScheduleYear12345BV year 5Percentage33.33%44.45%14.81%7.41%No MoreDep.Depreciation Expense333,300444,500148,10074,10000AT-Salvage =30,000

Income Statement-OCFYear12345Cost Savings300,000300,000300,000300,000300,000Depr333,300444,500148,10074,1000EBIT-33,300-144,500151,900225,900300,000Taxes-13320-578006076090360120000NI-19,980-86,70091,140135,540180,000OCF313,320357,800239,240209,640180,000

CFFAYear012345OCF313,320357,800239,240209,640180,000NCS-1,000,00030,000 NWC00CFFA-1,000,000313,320357,800239,240209,640210,000

NPV$83,797.50IRR11.45%Depreciation Expense= initial cost * percentageOperating Cash Flow=(sales - costs)*(1 - tax rate) + depreciation*tax ratenote that sales = 0 and a cost savings is -costs

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FIN222 Summer2015 Lectures Lecture 4