Corporate_Finance_9th_edition_Solutions_Manual_FINAL0

34 aftertax salvage value 39600 using the tax shield

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Unformatted text preview: + 0.35($1,065,600) = ($1,100,000)(.65) + 0.35($355,200) + $209,250 + 285,000 Remember to include the NWC cost in Year 0, and the recovery of the NWC at the end of the project. The NPV of the project with these assumptions is: NPV = – $2,685,000 + ($994,720/1.12) + ($1,087,960/1.122) + ($1,333,570/1.123) NPV = $19,666.69 6. First, we will calculate the annual depreciation of the new equipment. It will be: Annual depreciation charge = $850,000/5 Annual depreciation charge = $170,000 The aftertax salvage value of the equipment is: Aftertax salvage value = $75,000(1 – 0.35) Aftertax salvage value = $48,750 Using the tax shield approach, the OCF is: OCF = $320,000(1 – 0.35) + 0.35($170,000) OCF = $267,500 Now we can find the project IRR. There is an unusual feature that is a part of this project. Accepting this project means that we will reduce NWC. This reduction in NWC is a cash inflow at Year 0. This reduction in NWC implies that when the project ends, we will have to increase NWC. So, at the end of the project, we will have a cash outflow to restore the NWC to its level before the project. We also must include the aftertax salvage value at the end of the project. The IRR of the project is: NPV = 0 = –$850,000 + 105,000 + $267,500(PVIFAIRR%,5) + [($48,750 – 105,000) / (1+IRR)5] IRR = 22.01% 7. First, we will calculate the annual depreciation of the new equipment. It will be: Annual depreciation = $420,000/5 Annual depreciation = $84,000 Now, we calculate the aftertax salvage value. The aftertax salvage value is the market price minus (or plus) the taxes on the sale of the equipment, so: Aftertax salvage value = MV + (BV – MV)tc 148 Very often, the book value of the equipment is zero as it is in this case. If the book value is zero, the equation for the aftertax salvage value becomes: Aftertax salvage value = MV + (0 – MV)tc Aftertax salvage value = MV(1 – tc) We will use this equation to find the aftertax salvage value since we know the book value is zero. So, the aftertax salvage value is: Aftertax salvage value = $60,000(1 – 0.34) Aftertax salvage value = $39,600 Using the tax shield approach, we find the OCF for the project is: OCF = $135,000(1 – 0.34) + 0.34($84,000) OCF = $117,660 Now we can find the project NPV. Notice that we include the NWC in the initial cash outlay. The recovery of the NWC occurs in Year 5, along with the aftertax salvage value. NPV = –$420,000 – 28,000 + $117,660(PVIFA10%,5) + [($39,600 + 28,000) / 1.15] NPV = $39,998.25 8. To find the BV at the end of four years, we need to find the accumulated depreciation for the first four years. We could calculate a table with the depreciation each year, but an easier way is to add the MACRS depreciation amounts for each of the first four years and multiply this percentage times the cost of the asset. We can then subtract this from the asset cost. Doing so, we get: BV4 = $8,400,000 – 8,400,000(0.2000 + 0.3200 + 0.1920 + 0.1150) BV4 = $1,453,200 The asset is sold at a gain to book value, so this gain is taxable. Aftertax salvage value = $1,900,000 + ($1,453,200 – 1,900,000)(.35) Aftertax salvage value = $1,743,620 9. We will begin by calculating the initial cash outlay, that is, the cash flow at Time 0. To undertake the project, we will have to purchase the equipment and increase net working capital. So, the cash outlay today for the project will be: Equipment NWC Total –$1,800,000 –150,000 –$1,950,000 149 Using the bottom-up approach to calculating the operating cash flow, we find the operating cash flow each year will be: Sales Costs Depreciation EBT Tax Net income The operating cash flow is: OCF = Net income + Depreciation OCF = $243,750 + 450,000 OCF = $693,750 To find the NPV of the project, we add the present value of the project cash flows. We must be sure to add back the net working capital at the end of the project life, since we are assuming the net working capital will be recovered. So, the project NPV is: NPV = –$1,950,000 + $693,750(PVIFA16%,4) + $150,000 / 1.164 NPV = $74,081.48 10. We will need the aftertax salvage value of the equipment to compute the EAC. Even though the equipment for each product has a different initial cost, both have the same salvage value. The aftertax salvage value for both is: Both cases: aftertax salvage value = $20,000(1 – 0.35) = $13,000 To calculate the EAC, we first need the OCF and NPV of each option. The OCF and NPV for Techron I is: OCF = – $45,000(1 – 0.35) + 0.35($270,000/3) = $2,250 NPV = –$270,000 + $2,250(PVIFA12%,3) + ($13,000/1.123) = –$255,342.74 EAC = –$255,342.74 / (PVIFA12%,3) = –$106,311.69 And the OCF and NPV for Techron II is: OCF = – $48,000(1 – 0.35) + 0.35($370,000/5) = –$5,300 NPV = –$370,000 – $5,300(PVIFA12%,5) + ($13,000/1.125) = –$381,728.76 EAC = –$381,728.76 / (PVIFA12%,5) = –$105,895.27 The two milling machines have unequal lives, so they can only be compared by expressing both on an equivalent annual basis, which is what the EAC meth...
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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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