Chapter 3, Problem 2Q

Assume a firm has earnings before depreciation and taxes of $200,000 and no depreciation. It is in a 25 percent tax bracket. a. Compute its cash flow using the following format: Earnings before depreciation and taxes _____Depreciation _____Earnings before taxes _____Taxes @ 25% _____Earnings after taxes _____Depreciation _____Cash Flow _____ b. Compute the cash flow for the company if depreciation is $200,000. Earnings before depreciation and taxes _____Depreciation _____Earnings before taxes _____Taxes @ 25% _____Earnings after taxes _____Depreciation _____Cash Flow _____ c. How large a cash flow benefit did the depreciation provide?

Assume a $40,000 investment and the following cash flows for two alternatives. Year                       Investment X                      Investment Y  1                               $6,000                               $15,000  2                                 8,000                                 20,000  3                                 9,000                                 10,000  4                               17,000                                     —  5                               20,000                                     — Which of the alternatives would you select under the payback method?

The Short-Line Railroad is considering a $140,000 investment in either of two companies. The cashflows are as follows:Year                   Electric Co.                   Water Works1..................         $85,000                         $30,0002..................           25,000                           25,0003..................           30,000                           85,0004–10............           10,000                           10,000a. Using the payback method, what will the decision be?b. Using the Net Present Value method, which is the better project? The discount rate is 10%.