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CFM4 Solns Chap 10(1)

# CFM4 Solns Chap 10(1) - CORPORATE FINANCIAL MANAGEMENT...

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C ORPORATE F INANCIAL M ANAGEMENT , Fourth Edition Solutions Manual , Chapter 10 Chapter 10 Questions 1. Cash flow. Incremental. After-tax. Ignored. 2. The net cash flow for the initial investment is made up of cash paid for new capital assets, change in net working capital, cash received on the sale of old equipment, and tax paid (saved) on the sale of old equipment. 3. Sunk costs should be excluded from a capital budgeting analysis because they are irrelevant to the decision. Sunk costs have already been spent and cannot be recovered whether the project is accepted or rejected, expanded or contracted, continued or abandoned. 4. CFAT = (ΔR - ΔE)(1 - T) + TΔD is the operating cash flows after-tax plus the depreciation tax shield equation. The change in cash flow is (ΔR - ΔE) and is multiplied by (1 - T) to get the after-tax cash flow. TΔD is the tax rate multiplied by the change in depreciation and is the tax shield from the depreciation expense. CFAT = (ΔR - ΔE - ΔD)(1- T) + ΔD is the net income plus depreciation equation. (ΔR - ΔE - ΔD) is earnings before tax. Multiplication by (1-T) changes earnings before tax to net income. To get cash flow, the non-cash expense, ΔD, must be added to net income. 5. Two types of non-operating cash flows that can occur during a project’s life are equipment overhauls and changes in net working capital. 6. Net salvage value = S -T(S - B) - (1 - T)REX + ΔW is the equation for net salvage value. S is the cash received from the sale of the equipment. The tax paid on this sale, T(S - B), is subtracted as a cash outflow. Note that if B exceeds S, there is a negative tax that, when subtracted, creates a tax credit. After-tax cleanup and removal expenses, (1 - T)REX, are also subtracted as a cash outflow. Finally, the release of working capital, ΔW, from the project is a cash inflow to the firm. 7. Financing charges are not normally accounted for in the cash flows of a capital budgeting analysis. Rather, financing charges are explicitly included in the discount rate, the project’s required return. 8. Change in net working capital is an important cash flow in the capital budgeting process because of the opportunity cost associated with using the cash for that project. The cash used for working capital in a project could have been used to finance another projecte or other investment, or could have been used to pay down debt. The time value of money captures this cost in the present value difference between the money put in at the start and the money recovered at the end of the project. 9. The nominal rate of return can be broken down into its two components, the real rate of return and inflation. (1 + r n ) = (1 + r r )(1 + i ) is the relationship between the nominal rate of return, the real rate of return and inflation, which reduces to Equation (7.5): r n = r r + i + i r r 10. Taxes are large expenses for firms. Current tax laws are important to the evaluation of a capital investment project because they affect the value of the project. A change in tax laws could potentially turn a positive-NPV project into a negative-NPV project—or the reverse, and tax laws change frequently.

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