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Unformatted text preview: CHAPTER 10 PROIECT CASH FLOWS AND RISK1. Operating Cash Flows and DepreciationAWBewcastle 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 eachof 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 straightline methodover four years and the firms tax rate is 40%. If the projects required return is 11%, what is the totalpresent value of the annual operating cash ows received over the projects fouryear 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 CL800,000 5.0000000?D 800,000 zooij500 000 " 500, 300,000 __ EQOOOO DBEmECIATIDN: 500,000 333,588 $30: 5000008 56fI,200,000 200000 2,4,   200 0 T4 aoqooo 500000 500,000 300,000 NI3 300,000 + 300 000 w :1: SUDDDO (H0(000,000 0200900 W710) (000,000 NCFTAX IA game WSlNE: 613:3 m .95 833zzoqooo CFO: 0 CDl=bOQ000 F0""mass NW: I=~HZ L err NW: *llwnmSuppose that Bewcastle uses Modied Accelerated Cost Recovery System (MACRS) depreciation ratesinstead. The applicable rates are 33%, 45%, 15%, and 7%, respectively. Recalculate the rmsoperating cash ows 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 loopoo 1,400,000 3, w "" 000,000 . 1000 000 .. (000 000 0IW $00,000 300,000 800,000 $00,0001 : 3%005 3%,000 ~ 640. 000  150,000 r 94000 D. 404,000 290,000 a 000 $0,000 BETLzoo,a)0~>e0.'+5 10,900 0ng00 2 I000 eZSlpOO T5640.000 242,400 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, Bpv PLus g5 aster:510000on01 (3:030 COP(953,400 Fowl (Lovmmoo Pal_.g""33,0 0173:66me F05= cott=5I5,(ooo F044WEB ' P2553 NW: Isnv. l OPT NW: tusslamazz A_CHAPTER 10  PROIECT CASH FLOWS AND RISK2. Project AnalysisBedwyn Inc. has summarized the expected cash flows from a proposed project below. 0 ll 2 AT 41Total Investment Outlay $500,000Operating Cash Flow $150,000 $150,000 $150,000 $150,000Total Terminal Cash Flow $70 I0008 20,000If the projecys required return is 12%, what is the projects W? BA'II Plus 9E Zagislzr:CE, = 500,000cm = 50,000FDl 5 g ICOZ: 220,000 G 150,000 + flopcso)an: 1Page NPV: 1:127. J, err NPV= $38.04The firm used its required return, or discount rate, of 12% to evaluate this project because it believesthe project is of average risk. Suppose that the project actually had lowerthanaverage risk, and theCFO thinks the discount rate should be riskadjusted. What effect would this have on the projectsNPV? increasef...FV IPV == 7 t(l w?) lBedwyn Inc. is going to use factory space for this project that it usually rents to other firms. IfBedwyn accepts this project, it will not be able to rent the space anymore. If the firm usuallygenerates $12,500 per year in aftertax leasing revenue from the factory space, what is the value ofthe project w en you consider this factor? Assume that Bedwyn still considers the project to haveaverage risk nd uses a required return of 12%.W all Wag Wham 5:; 02,600: 13ilraopuw$12,0130% BMI Plus LE WWW = 054,500m:o = 600,000001= 2330500(5%; ZZQOQDIZIW 1? lgquo*%sm>m: I 90353 NW: 1:127. \L cPr Nvaavr,ga_s.20Suppose Bedwyns management team discloses that nearly $500,000 in research and developmentcosts were incurred before the new project proposal was put together. What effect would this haveionithe project's NPV?This $500.000M be recouped mamas Of whctmr 7emqu Inc. doctch in W W0 W POSd 0? not: We will beg no mange. ,/\CHAPTER 10 PROJECT CASH FLOWS AND RISK3. Project Analysis: Initial Investment OutlayHallmere Inc. is considering a project that requires an investment in new equipment of $4,500,000and $500,000 in shipping and installation costs. Hallmere estimates that its accounts receivable andinventories need to increase by $900,000 to support the new project, some of which will be financedby an increase in spontaneous liabilities (accounts payable and accruals) of $500,000. What is theprojects initial investment outlay? (Take note of your result as you will use it later.)(50le 3 4,600, 000 05925010806 5.an 155,000,0003%: as 600 000 V ANwo 400,000INWRL INVESTMENTWet/{ABLE 3 5 000WC, =ACA9ACLN = mama600,000 = 400,000 4. Project Analysis: Annual Operating Cash FlowsAgain, consider Hallmere Inc., which purchased $4,500,000 worth of equipment that required$500,000 in shipping and installation costs. In addition, the rm's accounts receivable andinventories increased by $900,000 and its spontaneous liabilities increased by $500,000. If Hallmeredepreciates the full cost of the equipment using straightline depreciation over four years, what is theprojects annual depreciation expense?WWW: maafmas $5me 5 $1,250in ,a4% YEARS Ll Suppose the rm decides instead to depreciate the equipment using Modied Accelerated CostRecovery System (MACRS) rates. The equipment falls under the category of a threeyear life asset.The depreciation rates over the next four years will be 33%, 45%, 15%, and 7%, respectively. Whatwill the projects depreciation expense be in the first year if MACRS is used?Wmonm,. zoaacwaaz snag * MAUZSf/o2 155,000,000 a 0.6% = $1,050,000Hallmeres project is expected to generate net annual sales revenue of $7,500,000 at the end of eachof the next four years. Total operating costs (xed and variable costs excluding depreciation) areexpected to equal $4,300,000. Suppose the rm uses the straightline method to depreciate theequipment and the rms tax rate is 40%. What is the projects annual operating cash ow? 15ir.500.000 S DEP: Peon/t AcoveJ4,%00, 000 C TAX = 9561? 0403,200,000 3:60:00"1,250,000 DM60000 661_ C$0,000 TI, no 000 N1:+ i,z50,000 0002,420,000 MOP CHAPTER 10 PROJECT CASH FLOWS AND RISK5. Project Analysis: Terminal Year Cash FlowsAgain, consider Hallmere Inc., which purchased $4,500,000 worth of equipment that required$500,000 in shipping and installation costs. In addition, the rm's accounts receivable andinventories increased by $900,000 and its spontaneous liabilities increased by $500,000. Hallmeresnet annual sales revenue is expected to be $7,5 00,000 at the end of each of the next four years, andtotal operating costs [fixed and variable costs excluding depreciation) will be $4,300,000. Assumethat the firm uses the straightline depreciation method to depreciate the equipment.Suppose the equipment is expected to have a salvage value of $800,000 at the end of the projects lifein four years and the firm expects all of its investment in net working capital [NWC) to be returned. Ifthe firms tax rate is 40%, what is the project's total terminal cash flow?Temmm CF: Sam/nae wxwu: UT) + ANWC: 1$800000 (1 ~04) + $403,000= 480.000 + 100,000 6003.000 6. Project Analysis: NPV and [RRAgain, consider Hallmere Inc., which purchased $4,500,000 worth of equipment that required$500,000 in shipping and installation costs. In addition, the rms accounts receivable andinventories 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, andtotal operating costs (fixed and variable costs excluding depreciation) will be $4,300,000. Assumethat the rm uses the straightline depreciation method to depreciate the equipment and the rm'stax rate is 40%. The equipment is expected to have a salvage value of $800,000 at the end of theprojects life in four years, and the firm expects all of its investment in net working capital (NWC) tobe returned.If its required rate of return is 12%, what is the projects net present value (NPV) and internal rate of return (IRR)?T J? 2 3 4Total Investment Outlay "slqoolooo $ .$ 1Operating Cash Flow 2! 4201000 2! 4201000 2(1ZOIDOO Total Terminal Cash Flow M EFF1E Plus E SW:8?: 2 0,400,000 2&300' s F01 = 5 _ .Co; a 330qu 2,420,000 + 800, 000) g Should Hallmere accept the project? 172655 l2? 3 OPT l Kg: gl ' NPV: 2506104453 >0 000571....
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 Spring '08
 TitusPiersma
 Finance

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