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Unformatted text preview: 2,400,000 2,500,000 $2,450,000 931,000 $1,519,000 2,500,000 $4,019,000 0 0 $4,019,000 2 $7,350,000 2,400,000 2,500,000 $2,450,000 931,000 $1,519,000 2,500,000 $4,019,000 1,300,000 5,744,000 $11,063,000 –$1,300,000 –10,000,000 –$11,300,000 The book value of the equipment is: Book value = $10,000,000 – (2)($10,000,000/4) Book value = $5,000,000 So the taxes on the salvage value will be: Taxes = ($5,000,000 – 6,200,000)(.38) Taxes = –$456,000 212 This makes the aftertax salvage value: Aftertax salvage value = $6,200,000 – 456,000 Aftertax salvage value = $5,744,000 The NPV if we abandon the project after two years is: NPV = –$11,300,000 + $4,019,000/1.16 + $11,063,000/1.162 NPV = $386,266.35 If we abandon the project after three years, the cash flows are: Year Sales Operating costs Depreciation EBT Tax Net income +Depreciation Operating CF Change in NWC Capital spending Total cash flow 0 1 $7,350,000 2,400,000 2,500,000 $2,450,000 931,000 $1,519,000 2,450,000 $4,019,000 0 0 $4,019,000 2 $7,350,000 2,400,000 2,500,000 $2,450,000 931,000 $1,519,000 2,450,000 $4,019,000 0 0 $4,019,000 3 $7,350,000 2,400,000 2,500,000 $2,450,000 931,000 $1,519,000 2,450,000 $4,019,000 1,300,000 3,306,000 $8,625,000 –$1,300,000 –10,000,000 –$11,300,000 The book value of the equipment is: Book value = $10,000,000 – (3)($10,000,000/4) Book value = $2,500,000 So the taxes on the salvage value will be: Taxes = ($2,500,000 – 3,800,000)(.38) Taxes = –$494,000 This makes the aftertax salvage value: Aftertax salvage value = $3,800,000 – 494,000 Aftertax salvage value = $3,306,000 213 The NPV if we abandon the project after two years is: NPV = –$11,300,000 + $4,019,000(PVIFA16%,2) + $8,625,000/1.163 NPV = $677,099.31 We should abandon the equipment after three years since the NPV of abandoning the project after three years has the highest NPV. 29. a. The NPV of the project is sum of the present value of the cash flows generated by the project. The cash flows from this project are an annuity, so the NPV is: NPV = –$5,000,000 + $880,000(PVIFA10%,10) NPV = $407,219.05 b. The company will abandon the project if the value of abandoning the project is greater than the value of the future cash flows. The present value of the future cash flows if the company revises it sales downward will be: PV of downward revision = .50($290,000(PVIFA10%,9)/1.10) PV of downward revision = $759,144.05 Since this is less than the value of abandoning the project, the company should abandon in one year. So, the revised NPV of the project will be the initial cost, plus the expected cash flow in year one based on upward sales projection, plus the expected value of abandonment. We need to remember that the abandonment value occurs in year 1, and the present value of the expansion cash flows are in year one, so each of these must be discounted back to today. So, the project NPV under the abandonment or expansion scenario is: NPV = –$5,000,000 + $880,000 / 1.10 + .50($1,300,000) / 1.10 + [.50($1,750,000)(PVIFA10%,9)] / 1.10 NPV = $971,950.76 30. First, determine the cash flow from selling the old harvester. When calculating the salvage value, remember that tax liabilities or credits are generated on the difference between the resale value and the book value of the asset. Using the original purchase price of the old harvester to determine annual depreciation, the annual depreciation for the old harvester is: DepreciationOld = $50,000 / 15 DepreciationOld = $3,333.33 Since the machine is five years old, the firm has accumulated five annual depreciation charges, reducing the book value of the machine. The current book value of the machine is equal to the initial purchase price minus the accumulated depreciation, so: Book value = Initial Purchase Price – Accumulated Depreciation Book value = $50,000 – ($3,333.333 × 5 years) Book value = $33,333.33 214 Since the firm is able to resell the old harvester for $19,000, which is less than the $33,333 book value of the machine, the firm will generate a tax credit on the sale. The aftertax salvage value of the old harvester will be: Aftertax salvage value = Market value + tC(Book value – Market value) Aftertax salvage value = $18,000 + .34($33,333.33 – 18,000) Aftertax salvage value = $23,213.33 Next, we need to calculate the incremental depreciation. We need to calculate depreciation tax shield generated by the new harvester less the forgone depreciation tax shield from the old harvester. Let P be the breakeven purchase price of the new harvester. So, we find: Depreciation tax shieldNew = (Initial Investment / Economic Life) × tC Depreciation tax shieldNew = (P / 10) (.34) And the depreciation tax shield on the old harvester is: Depreciation tax shieldOld = ($50,000 / 15) (.34) Depreciation tax shieldOld = ($3,333.33)(0.34) So, the incremental depreciation tax, which is the depreciation tax shield from the new harvester, minus the depreciation tax shield from the old harvester, is: Incremental depreciation tax shield = (P / 10)(.34) – ($3,333.33)(.34) Incremental depreci...
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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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