Problem_Set__10_Solutions (2)

pdf

School

Brigham Young University *

*We aren’t endorsed by this school

Course

401

Subject

Finance

Date

Jan 9, 2024

Type

pdf

Pages

Uploaded by SuperHumanGiraffe808

Fin 401 Problem Set #10 Discounted Cash Flow Analysis Solutions 1. a. You are performing a discounted cash flow analysis on a project that requires a special piece of machinery that is owned by your firm but that is no longer being used in any other capacity. If your firm sold the machinery today, it would probably sell for about $10,000. The machinery was purchased for $50,000 two years earlier. One year ago, your firm spent an additional $20,000 to modify the machine. What cash flow should you include for the cost of the machine in your DCF analysis? (Ignore tax consequences for now.) $10,000. The opportunity cost is what matters here. Both the $50,000 and the $20,000 are sunk. b. Now reconsider the question including tax consequences. Assume that the current book value of the machinery is $5,000, and that the tax rate is 50%. What cash flow should you include for the cost of the machine in your DCF analysis? If you sold the machine today you would get $10,000, but you would also pay taxes on the gain over book value (so you’d pay half of the $5,000 gain). RV-(RV-BV)*t=10,000-(10,000-5,000).5=7,500 c. Answer (b) again assuming the book value is $25,000. Now you have a tax shield because you are taking a loss relative to book value. RV-(RV-BV)*t=10,000-(10,000-25,000).5=17,500 d. Answer (b) one more time assuming the book value is $10,000. If the resale value equals the book value, there are no tax consequences. RV-(RV-BV)*t=10,000-(10,000-10,000).5=10,000

2. Calculate the annual free cash flow for 2015 based on the following information. FCF = EBIT*(1-t) + Depreciation – CAPX – Change in operating NWC = 250*(1-.4) + 50 – 150 – 20 = 30 CAPX = Change in PP&E + Depreciation = (200 – 100 + 50) = 150 Change in operating NWC = (Current operating assets in 2015 – current operating liabilities in 2015) – (Current operating assets in 2014 – current operating liabilities in 2014) = (50 + 120 + 130 – 200) – (70 + 170 + 160 – 280) = 20 Income Statement Balance Sheets 2015 2014 2015 Revenue 1100 Cash 50 70 COGS 700 Accounts receivable 120 170 Opera@ng expenses 100 Inventory 130 160 Deprecia@on 50 Total current assets 300 400 EBIT 250 Interest expense 50 Net PPE 100 200 Pretax Income 200 Total assets 400 600 Tax 80 Net income 120 Accounts payable 200 280 Short-term debt 40 60 Total current liabili@es 240 340 Long-term debt 140 150 Total liabili@es 380 490 Shareholder's equity 20 110 3

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help

3. Your company is planning to purchase a piece of machinery for $100,000. The machinery has a useful life of 5 years, and your company will use straight-line depreciation to a salvage value of zero at the end of year 5. However, your company intends to use the machinery for only 2 years. At the end of the year 2, the machinery will be sold to a competitor that has agreed to purchase it at that time for $50,000. Your company is highly profitable, and its marginal tax rate is 30%. What is the after-tax cash flow that you would project for the sale of the machinery at the end of year 2? With straight line, depreciation is $20,000 per year, so book value will be 60,000 after two years. Cash flow consists of proceeds from sale plus tax consequences. The company will get a tax shield on the loss relative to book value. Remember RV-(RV-BV)*t After-tax cash flow is 50,000 – (50,000-60,000)*.3 =53,000 4. Wishbone Corp. is considering investing in a project with a projected life of 4 years. The project would require a $60,000 initial investment in machinery, and the machinery is in the 3-year MACRS category. The machinery is expected to be sold for $5,000 at the end of the project. The company has a 40% tax rate. The project is expected to bring $35,000 in incremental annual revenues and $10,000 incremental annual expenses for each of the 4 years. A $5,000 additional (one-time) investment in net working capital will be required, which will be recouped at the end of the project. Wishbone considers a WACC of 15% to be appropriate for this project. What is the NPV of this project? (You can do this by hand or in Excel. If you do the problem in Excel, print out and attach your spreadsheet. You can find a MACRS table online.) 0 1 2 3 4 4

5. Do Higgins, Chapter 7, #12. In addition to the assumptions given on the spreadsheet, assume that there is no change in working capital required, no additional capital expenditures, and that there is no resale value for the equipment. (Answer parts (a) through (e), and print out and attach your spreadsheet.) a. Complete the spreadsheet below by estimating the project's annual after tax cash flow. Sales Revenue $35,000 $35,000 $35,000 $35,000 Expenses $10,000 $10,000 $10,000 $10,000 Depreciation $19,998 $26,670 $8,886 $4,446 EBIT $5,002 ($1,670 ) $16,114 $20,554 Taxes @ 40% $2,001 ($668) $6,446 $8,222 EBIT(1-t) $3,001 ($1,002 ) $9,668 $12,332 CAPX $60,000 ($3,000) Δ NWC $5,000 $0 $0 $0 ($5,000) Cash Flows ($65,000 ) $22,999 $25,668 $18,554 $24,778 Net Present Value @ 15% $775 5

b. What is the investment's net present value at a discount rate of 10 percent? 12,923 c. What is the investment's internal rate of return? 11.0% d. How does the internal rate of return change if the discount rate equals 20 percent? It doesn't change. The IRR is independent of the discount rate. e. How does the internal rate of return change if the growth rate in EBIT is 8 percent instead of 3 percent? 12.8%. Change the “Growth rate in EBIT” assumption to 8% and observe the new IRR 6. Do Higgins, Chapter 7, #7. Answers in the back of the book. Facts and Assumptions Equipment initial cost $ 350,000 $ Depreciable life yrs. 7 Expected life yrs. 10 Salvage value $ $0 Straight line depreciation EBIT in year 1 28,000 Tax rate 38% Growth rate in EBIT 3% Discount rate 10% Year 0 1 2 3 4 5 6 7 8 9 10 Initial cost 350,000 Annual depreciation 50,000 50,000 50,000 50,000 50,000 50,000 50,000 EBIT 28,000 28,840 29,705 30,596 31,514 32,460 33,433 34,436 35,470 36,534 Taxes 10,640 10,959 11,288 11,627 11,975 12,335 12,705 13,086 13,478 13,883 EBIT after tax 17,360 17,881 18,417 18,970 19,539 20,125 20,729 21,351 21,991 22,651 After tax cash flow (350,000) $ 67,360 $ 67,881 $ 68,417 $ 68,970 $ 69,539 $ 70,125 $ 70,729 $ 21,351 $ 21,991 $ 22,651 $ Net present value @ 10% 12,923 $ Internal rate of return 11.0% 6

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version