NCF ($50,000) $11,300 $11,300 $11,300 $26,500 7. Voxland Industries purchased a computer for $10,000, which it will depreciate straight line over five years to a $1,000 salvage value. The computer will then be sold at that price. The company’s marginal tax rate is 40%. Calculate the cash flows associated with the computer from its purchase to its eventual sale including the years in between. ( Hint: Depreciate the difference between the cost of the computer and the salvage value. At the end of the depreciation life there’s a net book value remaining equal to the salvage value . ) SOLUTION: CF0 (10,000) CF1 720 (1800 depreciation x 40%) CF2 720 CF3 720 CF4 720 CF5 1,720 (Depreciation tax savings + $1,000 sale price) 8. Resolve the previous problem assuming Voxland uses the 5-year Modified Accelerated Cost Recovery System (MACRS) with no salvage value to depreciate the computer. Continue to assume the machine is sold after five years for $1,000. ( Hint: Apply the MACRS rules for computers in the chapter to the entire cost of the computer. Notice, however, that there will be a positive net book value after five years because MACRS takes five years of depreciation over six years due to the half-year convention.) SOLUTION: Cash flow in years 1-4 is just the tax saved by depreciation. Cash flow in year 5 is the tax saved by depreciation plus the proceeds from selling the machine less taxes on that sale. The taxable profit on the sale is $1,000 less the book value at that time. CF0 (10,000) CF1 800 (10,000 x 20% x 40%) CF2 1,280 (10,000 x 32% x 40%) CF3 768 (10,000 x 19.2% x 40%) CF4 460 (10,000 x 11.5% x 40%) CF5 1,292 (10,000 x 11.5% x 40%) + ($1,000 - [1,000– 580] x .4) 10
Cash Flow Estimation 9. Shelton Pharmaceuticals Inc. is introducing a new drug for pain relief. Management expects to sell 3 million units in the first year at $8.50 each, and anticipates 10% growth in sales per year thereafter. Operating costs are estimated at 70% of revenues. Shelton invested $20 million in depreciable equipment to develop and produce this product. The equipment will be depreciated straight line over 15 years to a salvage value of $2.0 million. Shelton’s marginal tax rate is 40%. Calculate the project’s operating cash flows in its third year. SOLUTION: ($000) Revenues $30,855.0 3,000 x (1.1) 2 x $8.50 Expenses 21,598.5 Revenues x 70% Depreciation 1,200.0 ($20,000 – $2,000)/15 EBT $ 8,056.5 Tax 3,222.6 EAT $ 4,833.9 Add Depreciation 1,200.0 Cash Flow $ 6,033.9 New Venture Cash Flows: Example 11-1 (page 498) 10. Harry and Flo Simone are planning to start a restaurant. Stoves, refrigerators, other kitchen equipment, and furniture are expected to cost $50,000 all of which will be depreciated straight line over five years. Construction and other costs of getting started will be $30,000. The Simones expect the following revenue stream. ($000) Year 1 2 3 4 5 6 7 Sales $60 $90 $140 $160 $180 $200 $200 Food costs are expected to be 35% of revenues while other variable expenses are forecast at 25% of revenues. Fixed overhead will be $40,000 per year. All operating expenses will be paid in cash, revenues will be collected immediately and inventory is negligible, so working capital need not be considered. Assume the combined state and federal tax rate is 25%. Do not assume a tax credit in loss years and ignore tax loss carry forwards. (Taxes are simply zero when EBT is a loss.) Develop a cash flow forecast for the Simones’ restaurant.
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