Corporate_Finance_9th_edition_Solutions_Manual_FINAL0

34 0343600004 ocfa 38700 npva 360000 38700pvifa114

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Unformatted text preview: od does. Thus, you prefer the Techron II because it has the lower (less negative) annual cost. $1,100,000 275,000 450,000 $375,000 131,250 $243,750 150 Intermediate 11. First, we will calculate the depreciation each year, which will be: D1 = $530,000(0.2000) = $106,000 D2 = $530,000(0.3200) = $169,600 D3 = $530,000(0.1920) = $101,760 D4 = $530,000(0.1150) = $60,950 The book value of the equipment at the end of the project is: BV4 = $530,000 – ($106,000 + 169,600 + 101,760 + 60,950) = $91,690 The asset is sold at a loss to book value, so this creates a tax refund. After-tax salvage value = $70,000 + ($91,690 – 70,000)(0.35) = $77,591.50 So, the OCF for each year will be: OCF1 = $230,000(1 – 0.35) + 0.35($106,000) = $186,600.00 OCF2 = $230,000(1 – 0.35) + 0.35($169,600) = $208,860.00 OCF3 = $230,000(1 – 0.35) + 0.35($101,760) = $185,116.00 OCF4 = $230,000(1 – 0.35) + 0.35($60,950) = $170,832.50 Now we have all the necessary information to calculate the project NPV. We need to be careful with the NWC in this project. Notice the project requires $20,000 of NWC at the beginning, and $3,000 more in NWC each successive year. We will subtract the $20,000 from the initial cash flow and subtract $3,000 each year from the OCF to account for this spending. In Year 4, we will add back the total spent on NWC, which is $29,000. The $3,000 spent on NWC capital during Year 4 is irrelevant. Why? Well, during this year the project required an additional $3,000, but we would get the money back immediately. So, the net cash flow for additional NWC would be zero. With all this, the equation for the NPV of the project is: NPV = – $530,000 – 20,000 + ($186,600 – 3,000)/1.14 + ($208,860 – 3,000)/1.142 + ($185,116 – 3,000)/1.143 + ($170,832.50 + 29,000 + 77,591.50)/1.144 NPV = $56,635.61 12. If we are trying to decide between two projects that will not be replaced when they wear out, the proper capital budgeting method to use is NPV. Both projects only have costs associated with them, not sales, so we will use these to calculate the NPV of each project. Using the tax shield approach to calculate the OCF, the NPV of System A is: OCFA = –$105,000(1 – 0.34) + 0.34($360,000/4) OCFA = –$38,700 NPVA = –$360,000 – $38,700(PVIFA11%,4) NPVA = –$480,064.65 151 And the NPV of System B is: OCFB = –$65,000(1 – 0.34) + 0.34($480,000/6) OCFB = –$15,700 NPVB = –$480,000 – $15,700(PVIFA11%,6) NPVB = –$546,419.44 If the system will not be replaced when it wears out, then System A should be chosen, because it has the less negative NPV. 13. If the equipment will be replaced at the end of its useful life, the correct capital budgeting technique is EAC. Using the NPVs we calculated in the previous problem, the EAC for each system is: EACA = – $480,064.64 / (PVIFA11%,4) EACA = –$154,737.49 EACB = – $546,419.44 / (PVIFA11%,6) EACB = –$129,160.75 If the conveyor belt system will be continually replaced, we should choose System B since it has the less negative EAC. 14. Since we need to calculate the EAC for each machine, sales are irrelevant. EAC only uses the costs of operating the equipment, not the sales. Using the bottom up approach, or net income plus depreciation, method to calculate OCF, we get: Machine A –$3,675,000 –180,000 –400,000 –$4,255,000 1,489,250 –$2,765,750 400,000 –$2,365,750 Machine B –$3,150,000 –110,000 –600,000 –$3,860,000 1,351,000 –$2,509,000 600,000 –$1,909,000 Variable costs Fixed costs Depreciation EBT Tax Net income + Depreciation OCF The NPV and EAC for Machine A is: NPVA = –$2,400,000 – $2,365,750(PVIFA10%,6) NPVA = –$12,703,458.00 EACA = – $12,703,458.00 / (PVIFA10%,6) EACA = –$2,916,807.71 152 And the NPV and EAC for Machine B is: NPVB = –$5,400,000 – 1,909,000(PVIFA10%,9) NPVB = –$16,393,976.47 EACB = – $16,393,976.47 / (PVIFA10%,9) EACB = –$2,846,658.91 You should choose Machine B since it has a less negative EAC. 15. When we are dealing with nominal cash flows, we must be careful to discount cash flows at the nominal interest rate, and we must discount real cash flows using the real interest rate. Project A’s cash flows are in real terms, so we need to find the real interest rate. Using the Fisher equation, the real interest rate is: 1 + R = (1 + r)(1 + h) 1.15 = (1 + r)(1 + .04) r = .1058 or 10.58% So, the NPV of Project A’s real cash flows, discounting at the real interest rate, is: NPV = –$50,000 + $30,000 / 1.1058 + $25,000 / 1.10582 + $20,000 / 1.10583 NPV = $12,368.89 Project B’s cash flow are in nominal terms, so the NPV discounted at the nominal interest rate is: NPV = –$65,000 + $29,000 / 1.15 + $38,000 / 1.152 + $41,000 / 1.153 NPV = $15,909.02 We should accept Project B if the projects are mutually exclusive since it has the highest NPV. 16. To determine the value of a firm, we can simply find the present value of the firm’s future cash flows. No depreciation is given, so we can assume depreciation is zero. Using the tax shield approach, we can find the present value of the aftertax revenues, and the present value of the aftertax costs. The required return, growth rates, price, and costs are all given in real ter...
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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 Texas-Tyler.

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