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Part 4 Ch 07

# Part 4 Ch 07 - CHAPTER 7 INTEGRATIVE PROBLEM 7-12 UNILATE...

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CHAPTER 7 INTEGRATIVE PROBLEM ANSWER : You might want to begin discussion differentiating between cash flow versus accounting income. 105 7-12 UNILATE TEXTILES IS EVALUATING A NEW PRODUCT, A SILK/WOOL BLENDED FABRIC. ASSUME THAT YOU WERE RECENTLY HIRED AS ASSISTANT TO THE DIRECTOR OF CAPITAL BUDGETING, AND YOU MUST EVALUATE THE NEW PROJECT. THE FABRIC WOULD BE PRODUCED IN AN UNUSED BUILDING ADJACENT TO UNILATE’S SOUTHERN PINES, NORTH CAROLINA PLANT. UNILATE OWNS THE BUILDING, WHICH IS FULLY DEPRECIATED. THE REQUIRED EQUIPMENT WOULD COST \$200,000, PLUS AN ADDITIONAL \$40,000 FOR SHIPPING AND INSTALLATION. IN ADDITION, INVENTORIES WOULD RISE BY \$25,000, WHILE ACCOUNTS PAYABLE WOULD GO UP BY \$5,000. ALL OF THESE COSTS WOULD BE INCURRED AT YEAR 0. BY A SPECIAL RULING, THE MACHINERY COULD BE DEPRECIATED UNDER THE MACRS SYSTEM AS 3-YEAR PROPERTY. THE PROJECT IS EXPECTED TO OPERATE FOR FOUR YEARS, AT WHICH TIME IT WILL BE TERMINATED. THE CASH INFLOWS ARE ASSUMED TO BEGIN ONE YEAR AFTER THE PROJECT IS UNDERTAKEN, OR AT t = 1, AND TO CONTINUE OUT TO t = 4. AT THE END OF THE PROJECT'S LIFE (t = 4), THE EQUIPMENT IS EXPECTED TO HAVE A SALVAGE VALUE OF \$25,000. UNIT SALES ARE EXPECTED TO TOTAL 100,000 FIVE-YARD ROLLS PER YEAR, AND THE EXPECTED SALES PRICE IS \$2.00 PER ROLL. CASH OPERATING COSTS FOR THE PROJECT (TOTAL OPERATING COSTS LESS DEPRECIATION) ARE EXPECTED TO TOTAL 60 PERCENT OF DOLLAR SALES. UNILATE’S MARGINAL TAX RATE IS 40 PERCENT, AND ITS REQUIRED RATE OF RETURN IS 10 PERCENT. TENTATIVELY, THE SILK/WOOL BLEND FABRIC PROJECT IS ASSUMED TO BE OF EQUAL RISK TO UNILATE’S OTHER ASSETS. YOU HAVE BEEN ASKED TO EVALUATE THE PROJECT AND TO MAKE A RECOMMENDATION AS TO WHETHER IT SHOULD BE ACCEPTED OR REJECTED. TO GUIDE YOU IN YOUR ANALYSIS, YOUR BOSS GAVE YOU THE FOLLOWING SET OF TASKS TO COMPLETE: A. DRAW A CASH FLOW TIME LINE THAT SHOWS WHEN THE NET CASH INFLOWS AND OUTFLOWS WILL OCCUR, AND EXPLAIN HOW THE TIME LINE CAN BE USED TO HELP STRUCTURE THE ANALYSIS.

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0 1 2 3 4 Cash flow time lines are helpful for showing where cash flows occur. When the data are developed and numbers have been put on the time line, it facilitates inputting the cash flows into a calculator to calculate the NPV, IRR, and payback. 106 ^ 1 CF ^ 2 CF ^ 3 CF ^ 4 CF k% B. UNILATE HAS A STANDARD FORM THAT IS USED IN THE CAPITAL BUDGETING PROCESS; SEE TABLE IP7-1. PART OF THE TABLE HAS BEEN COMPLETED, BUT YOU MUST REPLACE THE BLANKS WITH THE MISSING NUMBERS. TABLE IP7-1. UNILATE’S SILK/WOOL FABRIC PROJECT (\$ THOUSANDS) END OF YEAR: 0 1 2 3 4 UNIT SALES (THOUSANDS) 100 PRICE/UNIT \$ 2 .0 \$ 2 .0 TOTAL REVENUES \$200.0 COSTS EXCLUDING DEPRECIATION (\$120.0) DEPRECIATION ( 36 .0 ) ( 16 .8 ) TOTAL OPERATING COSTS (\$199 .2 ) (\$228 .0 ) EARNINGS BEFORE TAXES (EBT) \$44.0 TAXES ( 0 .3 ) 25 .3 NET INCOME \$26.4 DEPRECIATION 79 .2 36 .0 INCREMENTAL OPERATING CF \$ 79 .7 \$ 54 .7 EQUIPMENT COST INSTALLATION INCREASE IN INVENTORY INCREASE IN ACCOUNTS PAYABLE SALVAGE VALUE TAX ON SALVAGE VALUE RETURN OF NET WORKING CAPITAL CASH FLOW TIME LINE (NET CF): (\$260 .0 ) \$ 89 .7 CUMULATIVE CF FOR PAYBACK: ( 260.0) ( 180.3) 63.0 NPV = IRR = PAYBACK = COMPLETE THE TABLE IN THE FOLLOWING ORDER:
ANSWER : This answer requires no explanation. Students might note, though, that inflation is not

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