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Ch12ClassProblems1

# Ch12ClassProblems1 - previous two questions can you comment...

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1. Klang Audio Systems Klang Audio Systems is planning an expansion that involves buying more showroom space and acquiring a prufung, the latest in testing equipment. The prufbng costs \$42,000 and would be depreciated to a salvage value of zero in 7 years, even though it is expected to last 10 years. It is expected to have a market value of \$5,000 in year 10. The company spent \$7,000 to test the prufung, and the results were very favorable. The showroom space will cost \$100,000 and would be depreciated in 10 years to a salvage value of \$60,000. The showroom is expected to have a market value of \$40,000 in 10 years. This expansion will increase Klang's operating profits by \$30,000 a year. The company's marginal tax rate is 35% and its required rate of return is 12%. What are the annual cash flows for this project? What is the NPV of the expansion? What will the NPV be if the fm's required return were 16%? Based solely on your answers to the

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Unformatted text preview: previous two questions, can you comment on the IRR of the project? Depreciation on prufung = 42,000/7 = \$6,00O/year Depreciation on showroom = (100,000-60,000)/10 = \$4,00O/yr. Increase in profits (ARevenues - ACosts) = \$30,000 Cash outflows= prufung + showroom = -\$42,000-\$100,000 = -\$142,000 Cash flows = (AProfits - ADepreciation)(l -T) + Depreciation Cash flow, years 1-7 = (30,000- 10,000)(1-.35)+10,000 = \$23,000 Cash flow, years 8-10, not including salvage value = (30,000-4,000)(1-.35)+4,000 = \$20,900 Salvage value of prufung: Market value = 5,000 Book value = 0 Difference = 5,000, a capital gain Add \$5,000 to year 10 inflows Subtract additional taxes = 5,000 x .35 = \$1,750 Net value in year 10 = +\$3,250 Salvage value of showroom: Market value = 40,000 Book value = 60,000 Dif'ference = -20,000, a capital loss Tax credit = 20,000 x .35 = +\$7,000 Add \$40,000 + \$7,000 = \$47,000 to year 10 cash flows...
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Ch12ClassProblems1 - previous two questions can you comment...

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