FDHTFB Ydj
FDHTFB Ydj
FDHTFB Ydj
This project
requires the purchase of $52,000 of equipment which will be depreciated using straight-line
depreciation to a zero book value over the two years (Y1 and Y2). The equipment can be sold at the end
of the project for $34,000 (at the end of Y2). You will also need $16,000 in net working capital over the
life of the project (Y0, Y1, Y2 but NWC will be converted in cash at the end of Y2.). The fixed costs
will be $10,000 a year and the variable costs will be $70,000 per park. Your required rate of return is
10 percent for this project and your tax rate is 35 percent. What is the minimal amount you should bid
per amusement park?
You should find out the bid price at NPV=0. First, you can calculate both net capital spending and net
working capital.
Net Capital Spending = 52000 (Y0) - After tax salvage value (Y2)
After Tax salvage value in Y2 = 34,000 - 0.35(34,000-0) = 22,100 where the book value in Y2 is zero
because of 26,000 deprecation each year.
Net working capital = 16000 (Y0) + 0 (No change in Y1) -16000 (Y2)
a) What are incremental cash flows of capital spending for buying the new machine?
1. When you buy new machine, costs of new machine =$150,000 and sell original machine
In Y0, costs of new machine = $ 150,000 (cash outflows)
You will sell the original machine. After tax salvage value = 50,000 – 0.4 (50,000-40,000) = $46,000
(cash inflows)
Total new cash inflow = -104,000
In Y3, opportunity costs of buying new machine is after tax salvage vale of the original machine because
the company loses the opportunity to sell old machine if the company buy new machine.
After tax salvage value of the original machine = $20,000 – 0.4(20,000-0) =$ 12,000 (cash outflows)
After tax salvage value of the new machine = $30,000 – 0.4 (30,000-0) = $18,000 (Cash inflows)
Total net cash inflow = 6,000
b) What are incremental cash flows of OCF for buying the new machine? You need to calculate
incremental OCF in Y1, Y2 and Y3. [Hint:∆ OCF = (∆EBIT) (1-Tax) + ∆Depreciation]
c) Evaluate incremental cash flows for new machine with NPV and decide whether the company should
buy the new machine. (5 points)
b) What is after- tax weight average cost of capital for this company? (This part has not been learned
yet. But, we will see this kind of question in the final exam. )
c) Should the firm buy and install the machine press? Why or why not?
Y0 = -600,000
Present Value of OCF for Y1~Y4 = Annual OCF PVAIF (r=0.08, T=4)= 192,000 (3.3121) =
635,923.2
Present Value of Inventory = - 50,000/(1.08) = - 46,296.3
First, net working captial does not change with these machines. We don’t have to consider it.
Second, net capital spending of machine A is 285,000 (Y0). However, after tax salvage value is zero.
NPV are calculated for machine A and B and then use the concept of EAC (Equivalent Annual Costs)
to compare annualized costs of both machines.
5. Four years ago, Cheese Snacks, Inc. purchased land located beside their factory at a price of
$739,000. The land is currently valued at $825,000. The company is now considering building a new
warehouse on that land. The construction cost of the warehouse is estimated at $460,000. What is the
initial cash outflow that should be used when analyzing this project?
The opportunity costs should be included. But, which one is more important, book value or market
value? The market value should reflect the real costs. Thus, initial cash outflows = 825,000 + 460,000
= $1,285,000