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# Week5 - 12-1 Equipment NWC Investment Initial investment...

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12-1 Equipment \$ 9,000,000 NWC Investment 3,000,000 Initial investment outlay \$12,000,000 12-2 Operating Cash Flows: t = 1 Sales revenues \$10,000,000 Operating costs 7,000,000 Depreciation 2,000,000 Operating income before taxes \$ 1,000,000 Taxes (40%) 400,000 Operating income after taxes \$ 600,000 Add back depreciation 2,000,000 Operating cash flow \$ 2,600,000 12-7 E(NPV) = 0.05(-\$70) + 0.20(-\$25) + 0.50(\$12) + 0.20(\$20) + 0.05(\$30) = -\$3.5 + -\$5.0 + \$6.0 + \$4.0 + \$1.5 = \$3.0 million. σ NPV = [0.05(-\$70 - \$3) 2 + 0.20(-\$25 - \$3) 2 + 0.50(\$12 - \$3) 2 + 0.20(\$20 - \$3) 2 + 0.05(\$30 - \$3) 2 ] 0.5 = \$23.622 million. CV = \$23.622 / \$3.0 = 7.874 4-1 DSO = 20 days; ADS = \$20,000; AR = ? DSO = AR / (S/360) = \$400,000. 20 = AR / \$20,000 AR = \$400,000 4-4 EPS = \$1.50; CFPS = \$3.00; P/CF = 8.0×; P/E = ? P/CF = 8.0 P/\$3.00 = 8.0 P = \$24.00. P/E = \$24.00/\$1.50 = 16.0 Mini Case Chapter12 a. Define “incremental cash flow.” Answer: This is the firm’s cash flow with the project minus the firm’s cash flow without the project. a. 1. Should you subtract interest expense or dividends when calculating project cash flow? Answer: The cash flow statement should not include interest expense or dividends. The return required by the investors furnishing the capital is already accounted for when we apply the 10 percent cost of capital discount rate, hence including financing flows would be "double counting." Put another way, if we deducted capital costs in the

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table, and thus reduced the bottom line cash flows, and then discounted those CFS by the cost of capital, we would, in effect, be subtracting capital costs twice. a. 2. Suppose the firm had spent \$100,000 last year to rehabilitate the production line site. Should this cost be included in the analysis? Explain. Answer: The \$100,000 cost to rehabilitate the production line site was incurred last year, and presumably also expensed for tax purposes. Since, it is a sunk cost , it should not be included in the analysis. a. 3. Now assume that the plant space could be leased out to another firm at \$25,000 a year. Should this be included in the analysis? If so, how? Answer: If the plant space could be leased out to another firm, then if Shrieves accepts this project, it would forgo the opportunity to receive \$25,000 in annual cash flows. This represents an opportunity cost to the project, and it should be included in the analysis. Note that the opportunity cost cash flow must be net of taxes, so it would be a \$25,000(1 - t) = \$25,000(0.6) = \$15,000 annual outflow. a. 4. Finally, assume that the new product line is expected to decrease sales of the firm’s other lines by \$50,000 per year. Should this be considered in the analysis? If so, how? Answer: If a project affects the cash flows of another project, this is an "externality" which must be considered in the analysis. If the firm's sales would be reduced by \$50,000, then the net cash flow loss would be a cost to the project. Note that this annual loss would not be the full \$50,000, because Shrieves would save on cash operating costs if its sales dropped. Note also that externalities can be positive as well as negative. b. Disregard the assumptions in part a. What is Shrieves’ depreciable basis?
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Week5 - 12-1 Equipment NWC Investment Initial investment...

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