Chap10onSol_partial

Chap10onSol_partial - CHAPTER 10 Making Capital Investment...

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1 CHAPTER 10 Making Capital Investment Decisions 1. (LO1) The $5 million acquisition cost of the land six years ago is a sunk cost. The $5.3 million current aftertax value of the land is an opportunity cost if the land is used rather than sold off. The $11.6 million cash outlay and $425,000 grading expenses are the initial fixed asset investments needed to get the project going. Therefore, the proper year zero cash flow to use in evaluating this project is $5,300,000 + 11,600,000 + 425,000 = $17,325,000 2. (LO1) Sales due solely to the new product line are: 19,000($12,000) = $228,000,000 Increased sales of the motor home line occur because of the new product line introduction; thus: 4,500($45,000) = $202,500,000 in new sales is relevant. Erosion of luxury motor coach sales is also due to the new mid-size campers; thus: 900($85,000) = $76,500,000 loss in sales is relevant. The net sales figure to use in evaluating the new line is thus: $228,000,000 + 202,500,000 – 76,500,000 = $354,000,000 3. (LO1) We need to construct a basic income statement. The income statement is: Sales $ 740,000 Variable costs 444,000 Fixed costs 173,000 Depreciation 75,000 EBT $ 48,000 Taxes@35% 16,800 Net income $ 31,200 4. (LO3) To find the OCF, we need to complete the income statement as follows: Sales $ 876,400 Costs 547,300 Depreciation 128,000 EBIT $ 201,100 Taxes@34% 68,374 Net income $ 132,726 The OCF for the company is: OCF = EBIT + Depreciation – Taxes OCF = $201,100 + 128,000 – 68,374 OCF = $260,726 The depreciation tax shield, also called the CCA tax shield, is the depreciation times the tax rate, so: Depreciation tax shield = t c Depreciation Depreciation tax shield = .34($128,000) Depreciation tax shield = $43,520 The depreciation tax shield shows us the increase in OCF by being able to expense depreciation.
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2 5. (LO3) To calculate the OCF, we first need to calculate net income. The income statement is: Sales $ 96,000 Variable costs 49,000 Depreciation 4,500 EBT $ 42,500 Taxes@35% 14,875 Net income $ 27,625 Teaching note: focus on the first approach and the tax shield approach. Using the most common financial calculation for OCF, we get: OCF = EBIT + Depreciation – Taxes OCF = $42,500 + 4,500 – 14,875 OCF = $32,125 The top-down approach to calculating OCF yields: OCF = Sales – Costs – Taxes OCF = $96,000 – 49,000 – 14,875 OCF = $32,125 The tax-shield approach is: OCF = (Sales – Costs)(1 – t C ) + t C Depreciation OCF = ($96,000 – 49,000)(1 – .35) + .35(4,500) OCF = $32,125 And the bottom-up approach is: OCF = Net income + Depreciation OCF = $27,625 + 4,500 OCF = $32,125 All four methods of calculating OCF should always give the same answer. 6.
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Chap10onSol_partial - CHAPTER 10 Making Capital Investment...

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