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Chapter 10 solution

Chapter 10 solution - Basic 1 The \$6 million acquisition...

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Basic 1. The \$6 million acquisition cost of the land six years ago is a sunk cost. The \$6.4 million current aftertax value of the land is an opportunity cost if the land is used rather than sold off. The \$14.2 million cash outlay and \$890,000 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 \$6,400,000 + 14,200,000 + 890,000 = \$21,490,000 2. Sales due solely to the new product line are: 19,000(\$13,000) = \$247,000,000 Increased sales of the motor home line occur because of the new product line introduction; thus: 4,500(\$53,000) = \$238,500,000 in new sales is relevant. Erosion of luxury motor coach sales is also due to the new mid-size campers; thus: 900(\$91,000) = \$81,900,000 loss in sales is relevant. The net sales figure to use in evaluating the new line is thus: \$247,000,000 + 238,500,000 – 81,900,000 = \$403,600,000

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3. We need to construct a basic income statement. The income statement is: Sales \$ 830,000 Variable costs 498,000 Fixed costs 181,000 Depreciation 77,000 EBT \$ 74,000 25,900 Net income \$ 48,100 4. To find the OCF, we need to complete the income statement as follows: Sales \$ 824,500 Costs 538,900 Depreciation 126,500 EBT \$ 159,100 54,094 Net income \$ 105,006 The OCF for the company is: OCF = EBIT + Depreciation – Taxes OCF = \$159,100 + 126,500 – 54,094 OCF = \$231,506 The depreciation tax shield is the depreciation times the tax rate, so: Depreciation tax shield = t c Depreciation Depreciation tax shield = .34(\$126,500) Depreciation tax shield = \$43,010 The depreciation tax shield shows us the increase in OCF by being able to expense depreciation. 5. To calculate the OCF, we first need to calculate net income. The income statement is: Sales \$ 108,000 Variable costs 51,000 Depreciation 6,800 EBT \$ 50,200 17,570 Net income \$ 32,630 Using the most common financial calculation for OCF, we get: OCF = EBIT + Depreciation – Taxes OCF = \$50,200 + 6,800 – 17,570 OCF = \$39,430
The top-down approach to calculating OCF yields: OCF = Sales – Costs – Taxes OCF = \$108,000 – 51,000 – 17,570 OCF = \$39,430 The tax-shield approach is: OCF = (Sales – Costs)(1 – t C ) + t C Depreciation OCF = (\$108,000 – 51,000)(1 – .35) + .35(6,800) OCF = \$39,430 And the bottom-up approach is: OCF = Net income + Depreciation OCF = \$32,630 + 6,800 OCF = \$39,430 All four methods of calculating OCF should always give the same answer. 6. The MACRS depreciation schedule is shown in Table 10.7. The ending book value for any year is the beginning book value minus the depreciation for the year. Remember, to find the amount of depreciation for any year, you multiply the purchase price of the asset times the MACRS percentage for the year. The depreciation schedule for this asset is: Year Beginning Book Value MACRS Depreciation Ending Book value 1 \$1,080,000.00 0.1429 \$154,332.00 \$925,668.00 2 925,668.00 0.2449 264,492.00 661,176.00 3 661,176.00 0.1749 188,892.00 472,284.00 4 472,284.00 0.1249 134,892.00 337,392.00 5 337,392.00 0.0893 96,444.00 240,948.00 6 240,948.00 0.0892 96,336.00 144,612.00 7 144,612.00 0.0893 96,444.00 48,168.00 8 48,168.00 0.0446 48,168.00 0 7. The asset has an 8 year useful life and we want to find the BV of the asset after 5 years. With straight-line depreciation, the depreciation each year will be: Annual depreciation = \$548,000 / 8 Annual depreciation = \$68,500 So, after five years, the accumulated depreciation will be: Accumulated depreciation = 5(\$68,500) Accumulated depreciation = \$342,500

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The book value at the end of year five is thus: BV 5 = \$548,000 – 342,500 BV 5 = \$205,500 The asset is sold at a loss to book value, so the depreciation tax shield of the loss is recaptured.
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