Cost savings 50000year 3 year MACRs Depreciation Required return 10 Tax Rate 40

Cost savings 50000year 3 year macrs depreciation

This preview shows page 19 - 23 out of 68 pages.

Cost savings = 50,000/year 3-year MACRs Depreciation Required return = 10% Tax Rate = 40% What are the cash flow consequences of selling the old machine today instead of in 5 years? Working Pro Forma Income Statements Year 1 2 3 4 5 Cost Savings $50,000 $50,000 $50,000 $50,000 $50,000 Depreciation New Old 49,550 (9,000) 67,500 (9,000) 22,500 (9,000) 10,500 (9,000) 0 (9,000) Incremental $40,500 $58,500 $13,500 $1,500 $(9,000) EBIT Taxes (0.4) $9,500 3,800 $(8,500) (3,400) $36,500 14,600 $48,500 19,400 $59,000 23,600 Net Income $5,700 $(5,100) $21,900 $29,100 $35,400 OCF $46,200 $53,400 $35,400 $30,600 $26,400 Incremental Net Capital Spending Year 0: Cost of New Machine = $150,000 (Outflow) After-tax Salvage on Old Machine = $65,000 0.4 (65,000 55,000) = $61,000 (Inflow) Incremental Net Capital Spending = $150,000 61,000 = $89,000 Year 5: After-tax Salvage on Old Machine = 10,000 0.4 (10,000 10,000) = 10,000 (Outflow because we no longer receive this) Year 0 1 2 3 4 5 OCF $46,200 $53,400 $35,400 $30,600 $26,400 NCS $(89,000) (10,000) Change in NWC - - - - - - Total Project Cash Flow $(89,000) $46,200 $53,400 $35,400 $30,600 $16,400 NPV = $54,812.10 IRR = 36.28%
Image of page 19
20 Chapter 7: Interest Rates and Bond Valuation Bond Definitions Coupon The stated interest payment made on a bond. Face Value / Par Value The principal amount of a bond that is repaid at the end of the term. Coupon Rate The annual coupon divided by the face value of a bond. Maturity The specified date on which the principal amount of a bond is paid. Yield to Maturity (YTM) The rate required in the market on a bond. Bond Value = PV of Coupons + PV of Face Amount = ? × ( 1− 1 (1+𝑟) 𝑡 𝑟 ) + ? (1+𝑟) 𝑡 Relationship between Coupon Rate and YTM YTM = Coupon Rate => Par Value = Bond Value YTM > Coupon Rate => Par Value > Bond Value (Discount Bond) YTM < Coupon Rate => Par Value < Bond Value (Premium Bond) Current Yield vs. Yield to Maturity Current Yield = Annual Coupon / Price YTM = Current Yield + Capital Gain Yield E.g. 10% coupon bond with semi-annual coupons, face value of 1,000, 20 years to maturity, $1197.93 Current Yield = $100 / $1197.93 = 8.35% Price in one year, assuming no change in YTM = $1193.68 Capital Gain Yield = $(1193.68 1197.93) / 1197.93 = - 0.35% YTM = 8.35% - 0.35% = 8%
Image of page 20
21 Interest Rate Risk Interest Rate Risk Changes in bond prices due to fluctuating interest rates. All other things being equal, Time to Maturity: The longer the time to maturity, the greater the interest rate risk. o Longer-term bonds have greater interest rate sensitivity because a large portion of a bond’s value comes from the face value. o Present value of this amount isn’t greatly affected by a small change in interest rates if the amount is to be received in one year. o On the other hand, even a small change in interest rate, once compounded for several years, can have significant effects on the present value. Coupon Rate: The lower the coupon rate, the greater the interest rate risk. o If two bonds with different coupon rates have the same maturity, then the value of the one with the lower coupon is proportionately more dependent on the face amount to be received at maturity. o Bond with higher coupon has larger cash flows early in its life, so its value is less sensitive to changes in the discount rate.
Image of page 21