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Unformatted text preview: We will find the aftertax salvage value of the equipment first, which will be: Market value Taxes Total $1,000,000 –340,000 $660,000 184 Remember, to calculate the taxes on the equipment salvage value, we take the book value minus the market value, times the tax rate. Using the same method as the headache only pill, the cash flows each year for the headache and arthritis pill will be: Year 1 $31,500,000 16,500,000 6,666,667 $8,333,333 2,833,333 $5,500,000 $12,166,667 Year 2 $31,500,000 16,500,000 6,349,206 $8,650,794 2,941,270 $5,709,524 $12,058,730 Year 3 $31,500,000 16,500,000 6,046,863 $8,953,137 3,044,067 $5,909,070 $11,955,933 Sales Production costs Depreciation EBT Tax Net income OCF So, the NPV of the headache and arthritis pill is: NPV = –$21,000,000 + $12,166,667 / 1.13 + $12,058,730 / 1.132 + ($11,955,933 + 660,000) / 1.133 NPV = $7,954,190.93 The company should manufacture the headache and arthritis remedy since the project has a higher NPV. 38. This is an indepth capital budgeting problem. Since the project requires an initial investment in inventory as a percentage of sales, we will calculate the sales figures for each year first. The incremental sales will include the sales of the new table, but we also need to include the lost sales of the existing model. This is an erosion cost of the new table. The lost sales of the existing table are constant for every year, but the sales of the new table change every year. So, the total incremental sales figure for the five years of the project will be: Year 1 $10,080,000 –1,125,000 $8,955,000 Year 2 $10,920,000 –1,125,000 $9,795,000 Year 3 $14,000,000 –1,125,000 $12,875,000 Year 4 $13,160,000 –1,125,000 $12,035,000 Year 5 $11,760,000 –1,125,000 $10,635,000 New Lost sales Total Now we will calculate the initial cash outlay that will occur today. The company has the necessary production capacity to manufacture the new table without adding equipment today. So, the equipment will not be purchased today, but rather in two years. The reason is that the existing capacity is not being used. If the existing capacity were being used, the new equipment would be required, so it would be a cash flow today. The old equipment would have an opportunity cost if it could be sold. As there is no discussion that the existing equipment could be sold, we must assume it cannot be sold. The only initial cash flow is the cost of the inventory. The company will have to spend money for inventory in the new table, but will be able to reduce inventory of the existing table. So, the initial cash flow today is: New table Old table Total –$1,008,000 112,500 –$895,500 185 In year 2, the company will have a cash outflow to pay for the cost of the new equipment. Since the equipment will be purchased in two years rather than now, the equipment will have a higher salvage value. The book value of the equipment in five years will be the initial cost, minus the accumulated depreciation, or: Book value = $16,000,000 – 2,288,000 – 3,920,000 – 2,800,000 Book value = $6,992,000 The taxes on the salvage value will be: Taxes on salvage = ($6,992,000 – 7,400,000)(.40) Taxes on salvage = –$163,200 So, the aftertax salvage value of the equipment in five years will be: Sell equipment Taxes Salvage value $7,400,000 –163,200 $7,236,800 Next, we need to calculate the variable costs each year. The variable costs of the lost sales are included as a variable cost savings, so the variable costs will be: Year 1 $4,536,000 –450,000 $4,086,000 Year 2 $4,914,000 –450,000 $4,464,000 Year 3 $6,300,000 –450,000 $5,850,000 Year 4 $5,922,000 –450,000 $5,472,000 Year 5 $5,292,000 –450,000 $4,842,000 New Lost sales Variable costs Now we can prepare the rest of the pro forma income statements for each year. The project will have no incremental depreciation for the first two years as the equipment is not purchased for two years. Adding back depreciation to net income to calculate the operating cash flow, we get: Year 1 $8,955,000 4,086,000 1,900,000 0 $2,969,000 1,187,600 $1,781,400 0 $1,781,400 Year 2 $9,795,000 4,464,000 1,900,000 0 $3,431,000 1,372,400 $2,058,600 0 $2,058,600 Year 3 $12,875,000 5,850,000 1,900,000 2,288,000 $2,837,000 1,134,800 $1,702,200 2,288,000 $3,990,200 Year 4 $12,035,000 5,472,000 1,900,000 3,920,000 $743,000 297,200 $445,800 3,920,000 $4,365,800 Year 5 $10,635,000 4,842,000 1,900,000 2,800,000 $1,093,000 437,200 $655,800 2,800,000 $3,455,800 Sales VC Fixed costs Dep. EBT Tax NI +Dep. OCF 186 Next, we need to account for the changes in inventory each year. The inventory is a percentage of sales. The way we will calculate the change in inventory is the beginning of period inventory minus the end of period inventory. The sign of this calculation will tell us whether the inventory change is a cash inflow, or a cash outflow. The inventory each year, and the inventory change, will be: Year 1 $1,008,000 1,092,000 –$84,000 Year 2 $1,092,000 1,400,000 –$308,000 Year 3 $1,400,000 1,316,000 $84,000 Year 4 $1,316,000 1,176,000 $140,000 Year 5 $1...
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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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