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Unformatted text preview: Chapter 12 Solutions to End-of-Chapter Problems 12-1 a. Equipment $ 9,000,000 NOWC Investment 3,000,000 Initial investment outlay $12,000,000 b. No, last years $50,000 expenditure is considered a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis. c. The potential sale of the building represents an opportunity cost of conducting the project in that building. Therefore, the possible after-tax sale price must be charged against the project as a cost. 12-2 a. Operating cash flows: t = 1 Sales revenues $10,000,000 Operating costs 7,000,000 Depreciation 2,000,000 Operating income before taxes $ 1,000,000 Taxes (40%) 400,000 Operating income after taxes $ 600,000 Add back depreciation 2,000,000 Operating cash flow $ 2,600,000 b. The cannibalization of existing sales needs to be considered in this analysis on an after-tax basis, because the cannibalized sales represent sales revenue the firm would realize without the new project but would lose if the new project is accepted. Thus, the after-tax effect would be to reduce the firms operating cash flow by $1,000,000(1 T) = $1,000,000(0.6) = $600,000. Thus, the firms OCF would now be $2,000,000 rather than $2,600,000. c. If the tax rate fell to 30%, the operating cash flow would change to: Operating income before taxes $1,000,000 Taxes (30%) 300,000 Operating income after taxes $ 700,000 Add back depreciation 2,000,000 Operating cash flow $2,700,000 Thus, the firms operating cash flow would increase by $100,000. 12-3 Equipments original cost $20,000,000 Depreciation (80%) 16,000,000 Book value $ 4,000,000 Gain on sale = $5,000,000 $4,000,000 = $1,000,000. Tax on gain = $1,000,000(0.4) = $400,000. AT net salvage value = $5,000,000 $400,000 = $4,600,000. 12-4 a. The applicable depreciation values are as follows for the two scenarios: Scenario 1 Scenario 2 Year (Straight-Line) (MACRS) 1 $200,000 $264,000 2 200,000 360,000 3 200,000 120,000 4 200,000 56,000 b. To find the difference in net present values under these two methods, we must determine the difference in incremental cash flows each method provides. The depreciation expenses cannot simply be subtracted from each other, as there are tax ramifications due to depreciation expense. The full depreciation expense is subtracted from Revenues to get operating income, and then taxes due are computed Then, depreciation is added to after-tax operating income to get the projects operating cash flow. Therefore, if the tax rate is 40%, only 60% of the depreciation expense is actually flow....
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This homework help was uploaded on 04/07/2008 for the course FNBSLW 344 taught by Professor Bocksteigle during the Spring '08 term at Wisc Whitewater.
- Spring '08