Chapter 6.docx

Chapter 6.docx - Chapter 6 Questions and Problems 1...

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Chapter 6 Questions and Problems 1 Calculating Project NPV Flatte Restaurant is considering the purchase of a \$7,500 soufflé maker. The soufflé maker has an economic life of five years and will be fully depreciated by the straight-line method. The machine will produce 1,300 soufflés per year, with each costing \$2.15 to make and priced at \$5.25. Assume that the discount rate is 14 percent and the tax rate is 34 percent. Should the company make the purchase? BASIC (Questions 1–10) 1 Calculating Project NPV The Best Manufacturing Company is considering a new investment. Financial projections for the investment are tabulated here. The corporate tax rate is 34 percent. Assume all sales revenue is received in cash, all operating costs and income taxes are paid in cash, and all cash flows occur at the end of the year. All net working capital is recovered at the end of the project. Year 0 Year 1 Year 2 Year 3 Year 4 Investment \$27,400 Sales revenue \$12,900 \$14,000 \$15,200 \$11,200 Operating costs 2,700 2,800 2,900 2,100 Depreciation 6,850 6,850 6,850 6,850 Net working capital spending 300 200 225 150 ? a Compute the incremental net income of the investment for each year. a Compute the incremental cash flows of the investment for each year. a Suppose the appropriate discount rate is 12 percent. What is the NPV of the project? 1 Calculating Project NPV Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of \$1.65 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which it will be worthless. The project is estimated to generate \$1.24 million in annual sales, with costs of \$485,000. The tax rate is 35 percent and the required return is 12 percent. What is the project’s NPV? 1 Calculating Project Cash Flow from Assets In the previous problem, suppose the project requires an initial investment in net working capital of \$285,000 and the fixed asset will have a market value of

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\$225,000 at the end of the project. What is the project’s Year 0 net cash flow? Year 1? Year 2? Year 3? What is the new NPV? 1 NPV and Modified ACRS In the previous problem, suppose the fixed asset actually falls into the three- year MACRS class. All the other facts are the same. What is the project’s Year 1 net cash flow now? Year 2? Year 3? What is the new NPV? 1 Project Evaluation Your firm is contemplating the purchase of a new \$530,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth \$50,000 at the end of that time. You will save \$186,000 before taxes per year in order processing costs, and you will be able to reduce working capital by \$85,000 (this is a one-time reduction). If the tax rate is 35 percent, what is the IRR for this project? 1 Project Evaluation Dog Up! Franks is looking at a new sausage system with an installed cost of \$345,000.
• Fall '16

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