chap008solutions

# chap008solutions - Solutions to Chapter 8 Using Discounted...

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Solutions to Chapter 8 Using Discounted Cash-Flow Analysis to Make Investment Decisions 12. a.If the office space would have remained unused in the absence of the proposed project, then the incremental cash outflow from allocating the space to the project is effectively zero. The incremental cost of the space used should be based on the cash flow given up by allocating the space to this project rather than some other use. b. One reasonable approach would be to assess a cost to the space equal to the rental income that the firm could earn if it allowed another firm to use the space. This is the opportunity cost of the space. 13. Cash flow = net income + depreciation – increase in NWC 1.2 = 1.2 + 0.4 – NWC NWC = \$0.4 million 14. Cash flow = profit – increase in inventory = \$10,000 – \$1,000 = \$9,000 15. NWC 2006 = \$32 + \$25 – \$12 = \$45 million NWC 2007 = \$36 + \$30 – \$26 = \$40 million Net working capital has decreased by \$5 million. 16. Depreciation expense per year = \$40/5 = \$8 million Book value of old equipment = \$40 – (3 × \$8) = \$16 million After-tax cash flow = \$18 – [0.35 × (\$18 – \$16)] = \$17.3 million 8-1

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17. Using the seven-year ACRS depreciation schedule, after five years the machinery will be written down to 22.30% of its original value: 0.2230 × \$10 million = \$2.230 million If the machinery is sold for \$4.5 million, the sale generates a taxable gain of: \$2.270 million This increases the firm’s tax bill by: 0.35 × \$2.270 = \$0.7945 million Thus: total cash flow = \$4.5 – \$0.7945 = \$3.7055 million 18. a.All values should be interpreted as incremental results from making the purchase. Earnings before depreciation \$1,500 Depreciation 1,000 Taxable income 500 Taxes 200 Net income 300 + Depreciation 1,000 Operating CF \$1,300 in years 1–6 Net cash flow at time 0 is: –\$6,000 + [\$2,000 × (1 – 0.40)] = –\$4,800 b. NPV = –\$4,800 + [\$1,300 × annuity factor(16%, 6 years)] = – 84 . 9 \$ (1.16) 0.16 1 0.16 1 \$1,300 \$4,800 6 - = × - × + c.Incremental CF in each year (using depreciation tax shield approach) is: [\$1,500 × (1 – 0.40)] + (depreciation × 0.40) Year Depreciation CF 0 n/a –\$4,800.00 1 \$1,200.00 1,380.00 2 1,920.00 1,668.00 3 1,152.00 1,360.80 4 691.20 1,176.48 5 691.20 1,176.48 6 345.60 1,038.24 09 . 137 \$ 16 . 1 24 . 038 , 1 \$ 16 . 1 48 . 176 , 1 \$ 16 . 1 48 . 176 , 1 \$ 16 . 1 80 . 360 , 1 \$ 16 . 1 668 , 1 \$ 16 . 1 380 , 1 \$ 800 , 4 \$ NPV 6 5 4 3 2 = + + + + + + - = 8-2
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• Winter '07
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