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1.
Requirement 1:
Fill in the missing numbers in the following income statement
(Do not include the dollar signs ($))
:
Sales
$
644,100
Costs
345,600
Depreciation
96,300
EBIT
$
Taxes (35%)
Net income
$
Requirement 2:
Calculate the OCF.
(Do not include the dollar sign ($).)
OCF
$
Requirement 3:
What is the depreciation tax shield?
(Do not include the dollar sign ($).)
Depreciation tax shield
$
Explanation:
To find the OCF, we need to complete the income statement as follows:
Sales
$
64
4,1
00
Variable
costs
34
5,6
00
Depreciatio
n
96,
30
0
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View Full DocumentEBIT
$
20
2,2
00
Taxes@35%
70,
77
0
Net income
$
13
1,4
30
The OCF for the company is:
OCF = EBIT + Depreciation – Taxes
OCF = $202,200 + 96,300 – 70,770
OCF = $227,730
The depreciation tax shield is the depreciation times the tax rate, so:
Depreciation tax shield = Depreciation(T)
Depreciation tax shield = 0.35($96,300)
Depreciation tax shield = $33,705
The depreciation tax shield shows us the increase in OCF by being able to expense depreciation.
2.
Cochrane, Inc., is considering a new threeyear expansion project that requires an initial fixed asset investment of
$2.46 million. The fixed asset will be depreciated straightline to zero over its threeyear tax life, after which time it
will be worthless. The project is estimated to generate $2,270,000 in annual sales, with costs of $1,260,000.
Required:
If the tax rate is 35 percent, what is the OCF for this project?
(Do not include the dollar sign ($). Enter your
answer in dollars, not millions of dollars (e.g., 1,234,567).)
OCF
$
Explanation:
Using the tax shield approach to calculating OCF (Remember the approach is irrelevant; the final answer will be the
same no matter which of the four methods you use.), we get:
OCF = (Sales – Costs)(1 – T) + Depreciation(T)
OCF = ($2,270,000 – 1,260,000)(1 – 0.35) + 0.35($2,460,000/3)
OCF = $943,500
3.
Cochrane, Inc., is considering a new threeyear expansion project that requires an initial fixed asset investment of
$2.37 million. The fixed asset will be depreciated straightline to zero over its threeyear tax life, after which time it
will be worthless. The project is estimated to generate $2,240,000 in annual sales, with costs of $1,230,000. Assume
the tax rate is 35 percent and the required return on the project is 10 percent.
Required:
What is the project’s NPV?
(Do not include the dollar sign ($). Negative amount should be indicated by a minus
sign. Enter your answer in dollars, not millions of dollars (e.g., 1,234,567). Round your answer to 2 decimal
places (e.g., 32.16).)
Net present value
$
Explanation:
Using the tax shield approach to calculating OCF (Remember the approach is irrelevant; the final answer will be the
same no matter which of the four methods you use.), we get:
OCF = (Sales – Costs)(1 – T) + Depreciation(T)
OCF = ($2,240,000 – 1,230,000)(1 – 0.35) + 0.35($2,370,000/3)
OCF = $933,000
Since we have the OCF, we can find the NPV as the initial cash outlay, plus the PV of the OCFs, which are an
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 Winter '08
 staff
 Depreciation, Income Statement, Taxes

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