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FIN 302- Exam #2 Notes (Madalyn)

FIN 302- Exam #2 Notes (Madalyn) - Exam 2 Wrap up Chapter 6...

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Exam 2 Wrap up Chapter 6. Other Issues: o What to use: Allocated vs. actual overhead? Answer: Use actual Overhead that is occurring as a result of your project occurring, actual overhead just not what the company is going to bill to your division. Actual overhead NOT allocated overhead (proportion of floor space/ factory/ relative size of your facility). (Review) taxes from asset sale: o Initial outlay, change in NWC not subject to taxation. o Asset sales revenue (at end of project) are taxable…but only the amount of the capital gain. Net Revenue from sale of asset= Sales price-Tc(Sales price- book value) In class: Excel capital budgeting: What is Analysis 4) Valuing projects with cash flows of unequal risk: Discount riskless cash flows by risk free rate, and risky cash flows by risky rate (or WACC if appropriate). Example: Initial outlay: $100,000, no salvage value Dep = $20,000 for 5 yrs, riskless cash flow Revenues (risky) $60,000 for 5 yrs Expenses (risky) $20,000 for 5 yrs Expenses (riskless – contracted labor) $10,000 for 5 yrs Riskless rate = 5% Risky rate = 10% Tax rate = 30% PV After- tax PV 0 1 2 3 4 5 -100000 -100000 init outlay -100000 Revs 60000 60000 60000 60000 60000 227447 159213 PV of rev 54545 49587 45079 40981 37255 Exp (risky) -20000 -20000 -20000 -20000 -20000 -75816 -53071 PV of exp -18182 -16529 -15026 -13660 -12418 Exp (riskless) -10000 -10000 -10000 -10000 -10000 -43295 - 30306.3 PV of exp -9524 -9070 -8638 -8227 -7835 Dep Tax shield 6000 6000 6000 6000 6000 25977 25977 PV of DTS 5714 5442 5183 4936 4701 1
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NPV 1813 2
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Practice Problems 1: SPROCKETS Compute the NPV of the following project: A project to manufacture SPROCKETS is being considered. a) Initial outlay is $100,000 to be depreciated straight line down to $0 in 10 years. The machine will be sold in year 5 for 50,000 and the project will end at that time . b) Revenues are expected to be $50,000 in year 1, and decrease at a rate of 5% per year. c) Variable expenses associated with the project are expected to be 20% of sales (revenues) for each year. d) Working capital will increase by $15,000 at time 0, increase by another $13,000 in year 1, and decrease by $28,000 at the end of 5 years. e) This project will decrease the sales revenue of the WIDGET division by $10,000 (before tax) per year but will increase sales of the GADGET division by $20,000 per year (before tax). All expenses associated with these divisions will remain unchanged. f) The Sprocket project will be funded with a $100,000, 10% bond issue. g) The firm discounts risky cash flows by the risky rate, and riskless cash flows by the risk free rate of 5%. The depreciation tax shield is the only riskless cash flow. h) The corporate tax rate is 30% i) If the project is accepted , the firm will hire consultants to decide how to market the SPROCKETS, at a cost of $4000 in year 1 (before tax) j) The firm’s WACC is 12%. The above project is of average risk to the firm. 3
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Practice problem 2: Compute the NPV of the following project to make WIDGETS. The project will involve the following outlays: A) A $25,000 study conducted last month determined that the Widgets project will produce annual revenues of $600,000 , and require annual variable costs estimated at 1/3 rd of sales. Revenues will increase at the rate of inflation of 5% per year . (I.e., the second year of revenues will be 5% greater than
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