# QZ07 - At t = 4 the project’s economic life is complete...

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Due on Monday October, 27, 2008, 11:59 p.m. Use following information to answer problems 1 – 4. Attach necessary work to prove your answers. Mills Mining is considering an expansion project. The proposed project has the following features: The project has an initial cost of \$500,000--this is also the amount which can be depreciated. If an accelerated method is used, the depreciation schedule: Year 1, 20%; Year 2, 50%; Year 3, 15%; Year 4, 10%; and Year 5, 5%. If the project is undertaken, at t = 0 the company will need to increase its inventories by \$50,000, and its accounts payable will rise by \$10,000. This net operating working capital will be recovered at the end of the project’s life ( t = 4). If the project is undertaken, the company will realize an additional \$600,000 in sales over each of the next four years (t = 1, 2, 3, 4). The company’s operating cost (not including depreciation) will equal \$400,000 a year. The company’s tax rate is 40 percent.

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Unformatted text preview: At t = 4, the project’s economic life is complete, but it will have a salvage value of \$50,000 • The project’s WACC = 10 percent. 1. What are the year–end free cash flow, NPV and IRR, if a straight-line depreciation method is used? Operating CF = Sales – Expenses = \$600K - \$400K = \$200K – depreciation/year (\$112,500*) = \$87,500 * 40% tax rate = \$35,000. \$87,500-\$35,000 = \$52,500 + cost of project/year (\$112,500) = \$165,000 *\$500,000-\$50,000 (salvage value) = \$450,000/4 = \$112,500 depreciation expense/year. See attached Excel doc for NPV and IRR. 2. What are the year–end free cash flow, NPV and IRR, if the above mentioned depreciation is used but there are tax-loss carry provisions [i.e., there’s a tax refund if you make losses]? 3. What are the year–end free cash flow, NPV and IRR, if the abovementioned depreciation is used but there are no tax-loss carry provisions [i.e., there’s no tax refund]? 4. Provide an intuition for the results you have just found....
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## This note was uploaded on 03/13/2011 for the course FIN 5013 taught by Professor Gosnell during the Spring '08 term at Oklahoma State.

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QZ07 - At t = 4 the project’s economic life is complete...

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