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We are considering the introduction of a new product. Currently we are in the 34 percent marginal tax bracket with a 15 percent required
rate of return or cost of capital. This project is expected to last 5 years and then, because this is somewhat of a fad product, be terminated.
The following information describes the new project: Cost of new plant and equipment $7,900,000 Shipping and installation costs
$ 100,000 Unit sales YEAR UNITS SOLD 1 70,000 2 120,000 3 140,000 4 80,000 5 60,000 Sales
price per unit $300/unit in years 1 through 4, $260/unit in year 5 Variable cost per unit $180/unit Annual fixed costs $200,000 Working
capital requirements There will be an initial workingcapital requirement of $100,000 just to get production started. For each year, the
total investment in net working capital will be equal to 10 percent of the dollar value of sales for that year. Thus, the investment in
working capital will increase during years 1 through 3, then decrease in year 4. Finally, all working capital is liquidated at the termination
of the project at the end of year 5. The depreciation method Use the simplified straightline method over 5 years. Assume that the plant
and equipment will have no salvage value after 5 years. a. Should Caledonia focus on cash flows or accounting profits in making its
capitalbudgeting decisions? Should the company be interested in incremental cash flows, incremental profits, total free cash flows, or
total profits? b. How does depreciation affect free cash flows? c. How do sunk costs affect the determination of cash flows? d. What is
the project’s initial outlay? e. What are the differential cash flows over the project’s life? f. What is the terminal cash flow? g. Draw a
cash flow diagram for this project. h. What is its net present value? i. What is its internal rate of return? j. Should the project be accepted?
Why or why not? k. In capital budgeting, risk can be measured from three perspectives. What are those three measures of a project’s
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This note was uploaded on 02/16/2012 for the course AMERICAN I American I taught by Professor Americaninternationcollege during the Spring '12 term at American Internation College.
 Spring '12
 AmericanInternationCollege

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