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**Unformatted text preview: **CHAPTER 10 — PROIECT CASH FLOWS AND RISK
1. Operating Cash Flows and Depreciation
AW
Bewcastle Technologies is evaluating a new project that requires $1,200,000 in new equipment.
Bewcastle estimates that the new project will generate $1,400,000 in annual sales at the end of each
of the next four years and that total operating gosts (variable and fixed costs excluding depreciation)
will equal $600,000. Suppose that the firm depreciates the equipment using the straight-line method
over four years and the firm’s tax rate is 40%. If the projects required return is 11%, what is the total
present value of the annual operating cash ﬂows received over the project’s four-year life?
L, cg, = o.
— 1,200,000 1,400,000 1,400,000 1,400,000 woopoo S
— 200,000 - 000 '- bO0,000 -' 900.000 CL
800,000 5.0000000?D 800,000 zooij
-500 000 "‘ 500, — 300,000 __ EQOOOO D
BEmECIATIDN: 500,000 333,588 $30:— 500‘0008 56f
I,200,000 ’ 200000 2,4,- “- -— 200 0 T
4 aoqooo 500000 500,000 300,000 NI
3 300,000 + 300 000 w :1: SUDDDO (H0
(000,000 0200900 W710“) (000,000 NCF
TAX I
A game WSlNE: 613:3 m .95 “8‘33”
zzoqooo CFO: 0 CDl=bOQ000 F0""‘
mass NW: I=~HZ L err NW: *‘lﬁlﬂwnm
Suppose that Bewcastle uses Modiﬁed Accelerated Cost Recovery System (MACRS) depreciation rates
instead. The applicable rates are 33%, 45%, 15%, and 7%, respectively. Recalculate the ﬁrm’s
operating cash ﬂows and find their total present value now (still assuming a required return of 11%).
l— j 5t 7 1‘
~ l,200,000 1,300,000 5400,000 lﬁoopoo 1,400,000 3
, w -"" 000,000 .— 1000 000 .. (000 000 0
IW‘ $00,000 300,000 800,000 $00,000
1 : 3%005 «3%,000 ~— 640. 000 —-— 150,000 r“ 94000 D
. 404,000 290,000 a 000 $0,000 BET
Lzoo,a)0~>e0.'+‘5 “10,900 --|0ng00 —— 2 I000 eZS’lpﬂOO T
5640.000 242,400 60,000 54200) qijwo m:
.1) mg wow?» 1%?)— M M 0);)
{A g @000 (a i 00 meow 552,000 5am) W
._ A Game, Bp‘vﬂ PLus g5 aster:
510000on01 (3:030 COP-(953,400 Fowl (Lovmmoo Pal—ﬂ
_“.g""’33,0 0173:66me F05=| cott=5I5,(ooo F044
W‘EB -' P2553 NW: Isnv. l OPT NW: tusslamazz A_
CHAPTER 10 - PROIECT CASH FLOWS AND RISK
2. Project Analysis
Bedwyn Inc. has summarized the expected cash flows from a proposed project below.
0‘ ll 2‘ AT 41
Total Investment Outlay -$500,000
Operating Cash Flow $150,000 $150,000 $150,000 $150,000
Total Terminal Cash Flow $70 I000
8 £20,000
If the projecys required return is 12%, what is the project’s W?
BA'II Plus 9E Zagislzr:
CE, = —500,000
cm = 50,000
FDl “ 5 g ‘ I
COZ: 220,000 G 150,000 + flopcso)
an: 1
Page NPV: 1:127. J, err NPV= $38.04
The firm used its required return, or discount rate, of 12% to evaluate this project because it believes
the project is of average risk. Suppose that the project actually had lower-than-average risk, and the
CFO thinks the discount rate should be risk—adjusted. What effect would this have on the project’s
NPV?
increase
f...—
FV I
PV == 7 t
(l w?) l
Bedwyn Inc. is going to use factory space for this project that it usually rents to other firms. If
Bedwyn accepts this project, it will not be able to rent the space anymore. If the firm usually
generates $12,500 per year in after-tax leasing revenue from the factory space, what is the value of
the project w en you consider this factor? Assume that Bedwyn still considers the project to have
average risk nd uses a required return of 12%.
W all Wag Wham“ 5:; 02,600: 13ilraopuw$12,013
“0% BMI Plus LE WWW = 054,500
m:o = «600,000
001= 2330500
(5%; ZZQOQD’IZIW 1? lgquo*%sm>
m: I ¥ 90353 NW: 1:127. \L cPr Nva-“avr,ga_s.20
Suppose Bedwyn’s management team discloses that nearly $500,000 in research and development
costs were incurred before the new project proposal was put together. What effect would this have
ionithe project's NPV?
This $500.000M be recouped mamas Of whctmr 7
emqu Inc. doctch in W W0 W P’O‘S‘d“ 0? not:
‘ We will beg no mange. ‘ ‘ ,/\
CHAPTER 10 — PROJECT CASH FLOWS AND RISK
3. Project Analysis: Initial Investment Outlay
Hallmere Inc. is considering a project that requires an investment in new equipment of $4,500,000
and $500,000 in shipping and installation costs. Hallmere estimates that its accounts receivable and
inventories need to increase by $900,000 to support the new project, some of which will be financed
by an increase in spontaneous liabilities (accounts payable and accruals) of $500,000. What is the
project’s initial investment outlay? (Take note of your result as you will use it later.)
(50le ‘3 4,600, 000 05925010806 5.an 155,000,000
3%: as 600 000 V ANwo 400,000
INWRL INVESTMENT
Wet/{ABLE ‘3 5 000
WC, =ACA9-ACL
N = mama-600,000 = 400,000
4. Project Analysis: Annual Operating Cash Flows
Again, consider Hallmere Inc., which purchased $4,500,000 worth of equipment that required
$500,000 in shipping and installation costs. In addition, the ﬁrm's accounts receivable and
inventories increased by $900,000 and its spontaneous liabilities increased by $500,000. If Hallmere
depreciates the full cost of the equipment using straight—line depreciation over four years, what is the
project’s annual depreciation expense?
WWW: maafmas $5me 5 $1,250in
,—
a
4% YEARS Ll
Suppose the ﬁrm decides instead to depreciate the equipment using Modiﬁed Accelerated Cost
Recovery System (MACRS) rates. The equipment falls under the category of a three—year life asset.
The depreciation rates over the next four years will be 33%, 45%, 15%, and 7%, respectively. What
will the project’s depreciation expense be in the first year if MACRS is used?
Wmonm,. zoaacwaaz snag * MAUZSf/o
2 155,000,000 a 0.6% = $1,050,000
Hallmere’s project is expected to generate net annual sales revenue of $7,500,000 at the end of each
of the next four years. Total operating costs (ﬁxed and variable costs excluding depreciation) are
expected to equal $4,300,000. Suppose the ﬁrm uses the straight-line method to depreciate the
equipment and the ﬁrm’s tax rate is 40%. What is the project’s annual operating cash ﬂow?
15i’r.‘500.000 S DEP: Peon/t Acove
J4,%00, 000 C TAX = 9-561”? 0‘40
3,200,000 3:60:00"
“1,250,000 D
M60000 661’
_ C$0,000 T
I, no 000 N1:
+ i,z50,‘000 000
2,420,000 MOP CHAPTER 10 — PROJECT CASH FLOWS AND RISK
5. Project Analysis: Terminal Year Cash Flows
Again, consider Hallmere Inc., which purchased $4,500,000 worth of equipment that required
$500,000 in shipping and installation costs. In addition, the ﬁrm's accounts receivable and
inventories increased by $900,000 and its spontaneous liabilities increased by $500,000. Hallmere’s
net annual sales revenue is expected to be $7,5 00,000 at the end of each of the next four years, and
total operating costs [fixed and variable costs excluding depreciation) will be $4,300,000. Assume
that the firm uses the straight-line depreciation method to depreciate the equipment.
Suppose the equipment is expected to have a salvage value of $800,000 at the end of the project’s life
in four years and the firm expects all of its investment in net working capital [NWC) to be returned. If
the firm’s tax rate is 40%, what is the project's total terminal cash flow?
Temmm CF: Sam/nae w—xwu’: U—T) + ANWC
: 1$800000 (1 ~04) + $403,000
= “480.000 + “£100,000
‘ 6003.000
6. Project Analysis: NPV and [RR
Again, consider Hallmere Inc., which purchased $4,500,000 worth of equipment that required
$500,000 in shipping and installation costs. In addition, the ﬁrm’s accounts receivable and
inventories increased by $900,000 and its spontaneous liabilities increased by $500,000. Hallmere's
{-0 net annual sales revenue is expected to be $7,500,000 at the end of each of the next four years, and
total operating costs (fixed and variable costs excluding depreciation) will be $4,300,000. Assume
that the ﬁrm uses the straight—line depreciation method to depreciate the equipment and the ﬁrm's
tax rate is 40%. The equipment is expected to have a salvage value of $800,000 at the end of the
project’s life in four years, and the firm expects all of its investment in net working capital (NWC) to
be returned.
If its required rate of return is 12%, what is the project’s net present value (NPV) and internal rate of
return (IRR)?
T J? 2 3 4
Total Investment Outlay "slqoolooo $ .$ -1
Operating Cash Flow 2! 4201000 2! 4201000 2(‘1‘ZOIDOO
Total Terminal Cash Flow
M EFF-1E Plus E SW:
8?: 2 «0,400,000 2&3“
00' s
F01 = 5 ‘_ .
Co; a 330qu 2,420,000 + 800, 000) g
- Should Hallmere accept the project? 172655 l2?— 3 OPT l Kg: gl '
ﬂ
NPV: “2506104453 >0 000571”. ...

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