Unit III Supplemental Practice Problems
1.
A corporation is considering investing $10 million in an expansion of its existing
operations.
The investment will involve the purchase of $10 million of fixed assets at
the start.
These assets will be depreciated over a 10-year period to a salvage value of
$500,000.
The firm will incur other start-up expenses of $2 million.
The tax rate is
30%.
Answer the following questions.
a.
Determine the after-tax cash flow at the start (i.e., the initial outlay).
b.
At the end of the 10
th
year, the equipment is expected to be sold for $750,000.
Determine the after-tax cash flow for this year based strictly on the sale of this
asset.
(i.e., ignore any cash flows from operations in that year.)
2.
A company has made the decision to invest in a new product.
After several years, the
project has been somewhat disappointing.
The company is re-assessing its remaining
expected cash flows.
Its forecasts show that annual sales are expected to be $2
million, and it will have cost of goods sold of $1.2 million and other expenses of
$250,000.
The company is currently charging depreciation of $400,000 a year.
The
tax rate is 30%.
An annual increase in net working capital of $200,000 is required.
Find the annual expected after-tax cash flow.
3.
The cost of capital is 16%.
Consider the following two projects, as indicated by their
expected cash flows:
Project
Initial Outlay
C
1
C
2
C
3
ABC
$100,000
$20,000
$75,000
$125,000
DEF
$300,000
$80,000
$210,000
$180,000
a.
Find the NPV of ABC and DEF.
If both projects can be accepted, which
project(s) would be accepted?
b.
Find the Profitability Index of both ABC and DEF.
c.
Based on your answer in a., would the internal rate of return of ABC be above or
below 16%.
How do you know?
d.
If the projects are mutually exclusive and there is no capital rationing, which, if
any, project(s) would be selected?
Explain your answer.
e.
If the projects are mutually exclusive and there is a capital budget of $300,000,
which, if any, project(s) would be selected?
Explain your answer.