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Unformatted text preview: + OCF(PVIFA14%,5) + [($75,000 + 39,000) / 1.145] So, the necessary OCF for a zero NPV is: OCF = $845,791.97 / PVIFA14%,5 = $246,365.29 Now we can use the tax shield approach to solve for the minimum quantity as follows: OCF = $246,365.29 = [(P – v)Q – FC ](1 – tc) + tcD $246,365.29 = [($14.00 – 8.50)Q – 210,000 ](1 – 0.35) + 0.35($830,000/5) Q = 90,843 As a check, we can calculate the NPV of the project with this quantity. The calculations are: Year Sales Variable costs Fixed costs Depreciation EBIT Taxes (35%) Net Income Depreciation Operating CF 1 $1,271,808 772,169 210,000 166,000 $123,639 43,274 $80,365 166,000 $246,365 2 $1,271,808 772,169 210,000 166,000 $123,639 43,274 $80,365 166,000 $246,365 3 $1,271,808 772,169 210,000 166,000 $123,639 43,274 $80,365 166,000 $246,365 4 $1,271,808 772,169 210,000 166,000 $123,639 43,274 $80,365 166,000 $246,365 5 $1,271,808 772,169 210,000 166,000 $123,639 43,274 $80,365 166,000 $246,365 174 Year Operating CF Change in NWC Capital spending Total CF 1 $246,365 0 0 $246,365 2 $246,365 0 0 $246,365 3 $246,365 0 0 $246,365 4 $246,365 0 0 $246,365 5 $246,365 75,000 39,000 $360,365 NPV = – $830,000 – 75,000 + $246,365(PVIFA14%,5) + [($75,000 + 39,000) / 1.145] $0 Note that the NPV is not exactly equal to zero because we had to round the number of cartons sold; you cannot sell onehalf of a carton. c. To find the highest level of fixed costs and still breakeven, we need to use the tax shield approach to calculating OCF, and solve the problem similar to finding a bid price. Using the initial cash flow and salvage value we already calculated, the equation for a zero NPV of the project is: NPV = 0 = – $830,000 – 75,000 + OCF(PVIFA14%,5) + [($75,000 + 39,000) / 1.145] OCF = $845,791.97 / PVIFA14%,5 = $246,365.29 Notice this is the same OCF we calculated in part b. Now we can use the tax shield approach to solve for the maximum level of fixed costs as follows: OCF = $246,365.29 = [(P–v)Q – FC ](1 – tC) + tCD $246,365.29 = [($14.00 – $8.50)(130,000) – FC](1 – 0.35) + 0.35($830,000/5) FC = $425,361.10 As a check, we can calculate the NPV of the project with this quantity. The calculations are: Year Sales Variable costs Fixed costs Depreciation EBIT Taxes (35%) Net Income Depreciation Operating CF Year Operating CF Change in NWC Capital spending Total CF 1 $1,820,000 1,105,000 425,361 166,000 $123,639 43,274 $80,365 166,000 $246,365 1 $246,365 0 0 $246,365 2 $1,820,000 1,105,000 425,361 166,000 $123,639 43,274 $80,365 166,000 $246,365 2 $246,365 0 0 $246,365 3 $1,820,000 1,105,000 425,361 166,000 $123,639 43,274 $80,365 166,000 $246,365 3 $246,365 0 0 $246,365 4 $1,820,000 1,105,000 425,361 166,000 $123,639 43,274 $80,365 166,000 $246,365 4 $246,365 0 0 $246,365 5 $1,820,000 1,105,000 425,361 166,000 $123,639 43,274 $80,365 166,000 $246,365 5 $246,365 75,000 39,000 $360,365 NPV = – $830,000 – 75,000 + $246,365(PVIFA14%,5) + [($75,000 + 39,000) / 1.145] ≈ $0 175 32. We need to find the bid price for a project, but the project has extra cash flows. Since we don’t already produce the keyboard, the sales of the keyboard outside the contract are relevant cash flows. Since we know the extra sales number and price, we can calculate the cash flows generated by these sales. The cash flow generated from the sale of the keyboard outside the contract is: Year 1 $1,100,00 0 660,000 $440,000 176,000 $264,000 Year 2 $3,300,00 0 1,980,000 $1,320,00 0 528,000 $792,000 Year 3 $3,850,00 0 2,310,000 $1,540,00 0 616,000 $924,000 Year 4 $1,925,00 0 1,155,000 $770,000 308,000 $462,000 Sales Variable costs EBT Tax Net income (and OCF) So, the addition to NPV of these market sales is: NPV of market sales = $264,000/1.13 + $792,000/1.132 + $924,000/1.133 + $462,000/1.134 NPV of market sales = $1,777,612.09 You may have noticed that we did not include the initial cash outlay, depreciation, or fixed costs in the calculation of cash flows from the market sales. The reason is that it is irrelevant whether or not we include these here. Remember that we are not only trying to determine the bid price, but we are also determining whether or not the project is feasible. In other words, we are trying to calculate the NPV of the project, not just the NPV of the bid price. We will include these cash flows in the bid price calculation. The reason we stated earlier that whether we included these costs in this initial calculation was irrelevant is that you will come up with the same bid price if you include these costs in this calculation, or if you include them in the bid price calculation. Next, we need to calculate the aftertax salvage value, which is: Aftertax salvage value = $200,000(1 – .40) = $120,000 Instead of solving for a zero NPV as is usual in setting a bid price, the company president requires an NPV of $100,000, so we will solve for a NPV of that amount. The NPV equation for this project is (remember to include the NWC cash flow at the beginning of the project, and the NWC recovery at the end): N...
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This note was uploaded on 07/10/2010 for the course FIN 6301 taught by Professor Eshmalwi during the Spring '10 term at University of TexasTyler.
 Spring '10
 eshmalwi
 Finance, Corporate Finance

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