week07_TutorialAnswers - SCHOOL OF BANKING AND FINANCE...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
FINS 1613 Tutorial Answers 1 SCHOOL OF BANKING AND FINANCE FINS1613 BUSINESS FINANCE Semester 2, 2010 TUTORIAL ANSWERS WEEK 7 – Capital Budgeting Applications II Please note that some answers are exact when rounded to 2 or 3 decimal places because of the use of PV tables rather than calculators. Multiple-choice Questions 1. Consider the following proposal to enter a new line of business: The new business will require the company to purchase additional fixed assets that will cost $600,000 at t = 0. For tax and accounting purposes, these costs will be depreciated on a straight- line basis over three years. (Annual depreciation will be $200,000 per year at t = 1, 2, and 3.). At the end of three years, the company will get out of the business and will sell the fixed assets at a salvage value of $100,000. The project will require a $50,000 increase in net operating working capital at t = 0, which will be recovered at t = 3. The company's marginal tax rate is 35 percent. The new business is expected to generate $2 million in sales each year (at t = 1, 2, and3). The operating costs excluding depreciation are expected to be $1.4 million per year. The project's cost of capital is 12 percent. What is the project's net present value (NPV)? a. $536,697 b. $ 86,885 c. $ 81,243 d. $ 56,331 e. $561,609 Answer is a. NPV – capital budgeting calculation (basic) Cost of fixed assets + Increase in net working capital $600,000 $50,000 $650,000 InitialOutlay = = += Depreciation: 0 1 2 3 Cost of fixed assets 600,000 Depreciation 200,000 200,000 200,000 Value of fixed assets 600,000 400,000 200,000 0
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
FINS 1613 Tutorial Answers 2 Operating cash flow: 1 2 3 Revenue 2,000,000 2,000,000 2,000,000 Operating costs 1,400,000 1,400,000 1,400,000 Depreciation 200,000 200,000 200,000 Operating income before taxes (EBIT) 400,000 400,000 400,000 Taxes on operating income (35%) 140,000 140,000 140,000 Net operating profit after taxes (NOPAT) 260,000 260,000 260,000 Add back depreciation 200,000 200,000 200,000 Net operating cash flow 460,000 460,000 460,000 Net salvage value = salvage value - tax = salvage value - (salvage value - book value) tax rate $100,000 ($100,000 $0) 35% $100,000 $35,000 $65,000 × = −× = −= Terminal cash flows = Net salvage value + Recovery of net working capital $65,000 $50,000 $115,000 =+= 0 1 2 3 Initial cash outlay -650000.00 Operating cash flows 460000.00 460000.00 460000.00 Terminal cash flows 115000.00 Net cash flows -650000.00 460000.00 460000.00 575000.00 PV of Net cash flows (discount rate 12%) -650000.00 410714.29 366709.18 409273.64 NPV 536697.11 2. (Note: You may or may not need to use all of this information, use only relevant information.) Mr Suds is considering introducing a new detergent. The firm has collected the following information about the proposed product from various divisions within the firm and through a market research survey that cost $45,000. The project has an anticipated economic life of 4 years. The company will have to purchase a new machine to produce the detergent. The machine has an up-front cost (t = 0) of $2 million. The machine will be depreciated on a straight-line basis over 4 years (that is, the company's depreciation expense will be $500,000 in each of the first four years (t = 1, 2, 3, and 4). The company anticipates that the machine will last for four years, and that after four years, its salvage value will equal zero.
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 09/22/2011 for the course FINS 1613 taught by Professor Drkhshim during the Three '10 term at University of New South Wales.

Page1 / 8

week07_TutorialAnswers - SCHOOL OF BANKING AND FINANCE...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online