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Capital Budgeting6

Capital Budgeting6 - D E 58 24.04 24.70 Assume that you are...

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Old Exam Questions - Capital Budgeting Page 36 of 55 Pages D. 24.04% E. 24.70% 58. Assume that you are given the following cash flows for a project. These are real dollars and have not been adjusted for inflation. The firm intends to analyze this project using infinite replication. The price of the project is expected to increase at a constant annual inflation rate of 6% (that is, the price will be \$8,000 in Year 0, \$10,099.82 in Year 4, \$12,750.78 in Year 8, etc.). The cash inflows for this project are expected to increase at a constant annual inflation rate of 5% (that is, the cash inflow will be \$3,150.00 in Year 1, \$3,307.50 in Year 2, etc.). Using the method demonstrated in class, and assuming that the correct risk-adjusted discount rate to use for all cash flows is 10 percent per year, determine the net present value for this infinitely replicated project. (Hint: you have to look at your inflows and outflows, and the time period for these flows, separately.) Year Cash Flow 0 -\$8,000.00 1 \$3,000.00 2 \$3,000.00 3 \$3,000.00 4 \$3,000.00 A. \$4,600.93 B. \$4,907.41 C. \$5,213.89 D. \$4,754.17 E. \$5,060.65 59. Assume that your company is considering a new project and has collected the following information about the project. (Note: You may or may not need to use all of this information, use only the information that is relevant.) The project has an anticipated economic life of 4 years. The company will have to purchase a new machine. The machine will have an up- front cost of \$2 million at Year 0. The machine will be depreciated on a straight-line basis over 4 years (that is, depreciation expense will be \$500,000 in each of Years 1-4). The company anticipates that the machine will last for four years, and that after four years, its salvage value will equal zero. If the company goes ahead with the proposed product, it will have an effect on the company’s net operating working capital. At the outset, Year 0, inventory will increase by \$140,000 and accounts payable will increase by \$40,000. At Year 4, the net operating working capital will be recovered after the project is completed. The project is expected to generate sales revenue of \$2 million in Year 1, \$3 million in Years 2 and 3, and \$2 million in Year 4. Each year the operating costs (not including depreciation) are expected to equal 50 percent of sales revenue. The company’s interest expense each year will be \$100,000.

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Old Exam Questions - Capital Budgeting Page 37 of 55 Pages The new project is expected to reduce the after-tax cash flows of the company’s existing products by \$250,000 a year (Years 1-4). The company’s overall WACC is 10 percent. However, the proposed project is riskier than the average project and the project’s WACC is estimated to be 12 percent. The company’s tax rate is 40 percent. Given this information, determine the net present value of the proposed project. (You may wish to use the table below to help organize the data.) Cash Flow Item Year 0 Year 1 Year 2 Year 3 Year 4 Sales \$2,000,000.00 \$3,000,000.00 \$3,000,000.00 \$2,000,000.00 Operating Costs -\$1,000,000.00 -\$1,500,000.00 -\$1,500,000.00 -\$1,000,000.00 Depreciation -\$500,000.00 -\$500,000.00 -\$500,000.00 -\$500,000.00 EBIT Taxes NOPAT Depreciation OCF Investment -\$2,000,000.00 NOWC -\$100,000.00 \$100,000.00 Cannibalization Free Cash Flow PV NPV
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Capital Budgeting6 - D E 58 24.04 24.70 Assume that you are...

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