baldwin exercise & pset 2 notes

Yale University: Econ 225The Balwin CompanyTF Sections: February 9th

Yale University: Econ 225

Econ 255: Balwing Company exerciseOperating Cash Flow

1 Assumptions

Price Increase / unit 2% Make sure you fill in your assumptions (Yellow boxes) according to the exercise in Lecture 6Cost increase / unit 10%Tax Rate 34%

2

US$ Year 1 Year 2 Year 3Net Income 100,000.0 163,200.0 249,696.0 Operating expenses (50,000.0) (88,000.0) (145,200.0)tax expense (10,200.0) (14,688.0) (29,000.6)Cash Flow from Operations 39,800.0 60,512.0 75,495.4

2 Sales and Expenses

US$ Year 1 Year 2 Year 3Units 5,000 8,000 12,000 Price per unit 20.0 20.4 20.8 Total Sales 100,000.0 163,200.0 249,696.0

Production Cost / Unit 10.0 11.0 12.1 Total Cost (50,000.0) (88,000.0) (145,200.0)

3 D&A Cost

US$ Year 0 Year 1 Year 2 Year 3Machine Value 100,000 Annual D&A 20,000 32,000 19,200

D&A Schedule 20.00% 32.00% 19.20%80.0% 48.0% 28.8%

Ending Book Value 80,000 48,000 28,800

4 Tax Calculation

US$ Year 1 Year 2 Year 3Sales 100,000.0 163,200.0 249,696.0 Cost (50,000.0) (88,000.0) (145,200.0)D&A (20,000.0) (32,000.0) (19,200.0)Taxable income 30,000.00 43,200.00 85,296.00Tax expense (10,200.0) (14,688.0) (29,000.6)Net Income 19,800.00 28,512.00 56,295.36

Cash Flows from Operations after tax (EBIT-Tax+D&A)

Remaining D&A

Make sure you fill in your assumptions (Yellow boxes) according to the exercise in Lecture 6

Year 4 Year 5 212,241.6 1,298,918.6

(133,100.0) (878,460.0)(22,991.3) (139,039.1)

56,150.3 281,419.5

Year 4 Year 5 10,000 60,000 21.2 21.6 212,241.6 1,298,918.6

13.3 14.6 (133,100.0) (878,460.0)

Year 4 Year 5

11,520 11,520 11.52% 11.52%

17.3% 5.8% 17,280 5,760

Year 4 Year 5 212,241.6 1,298,918.6

(133,100.0) (878,460.0)(11,520.0) (11,520.0)67,621.60 408,938.59(22,991.3) (139,039.1)44,630.26 269,899.47

Econ 255: Balwing Company exerciseNet Capital Spending (Capex)

1 Capital Expenses Cash Flows

US$ Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Net Capital Expenses (8,500,000) 1,354,464

2 Salvage Value

US$ Year 0 Year 1 Year 2 Year 3 Year 4 Year 5Machine Value 8,500,000 1,800,000 1,800,000 Annual D&A 1,700,000 2,720,000 1,632,000 979,200 979,200

D&A Schedule 20.00% 32.00% 19.20% 11.52% 11.52%80.00% 48.00% 28.80% 17.28% 5.76%

Ending Book Value 6,800,000 4,080,000 2,448,000 1,468,800 489,600

Taxable Capital Gain 331,200 1,310,400 Tax Expense 115,920 445,536 After Tax Salvage Value 1,684,080 1,354,464

Remaining D&A

Econ 255: Balwing Company ExerciseWorking Capital Calculations

1 Assumptions

Year 0 10,000.0

Year 2 - 4 (% sales) 10%Year 5 -

2 Working Capital Calculations

US$ Year 0 Year 1 Year 2Sales 100,000.0 163,200.0

Working Capital 10,000.00 10,000.00 16,320.00 (-Increase)/+Decrease in WC (10,000) - (6,320)


Year 3 Year 4 Year 5 249,696.0 212,241.6 1,298,918.6

24,969.60 21,224.16 - (8,650) 3,745 21,224

Econ 255: Balwing Company exerciseIncremental After Tax Cash Flows

1 Assumptions

Discount Rate 10%

2 Incremental After Tax Cash Flows

US$ Year 0 Year 1 Year 2 Year 3Operating Cash Flow 39,800 60,512 75,495Net Capital Expenses (8,500,000) - - -Change in WC (10,000) - (6,320) (8,650)Opportunity CostCanibalism - - - -Total Incremental CF after tax (8,510,000) 39,800 54,192 66,846

NPV Incremental CF after Tax (7,308,966)


Year 4 Year 556,150 281,419

- 1,354,4643,745 21,224

- -59,896 1,657,108

Problem Sets1. Compare the investment Criteria

Use a chartPayback periods: Surer the better; better to get the money back as soon as possible; will still accept if the Payback period is shorter than the cut of the yearsIRR Accept if IRR is larger than reference interest rate ; the larger the betterPI PI > 1; the larger the betterNPV NPV > 0; the larger the better

2 Initial InvestmentA -$ 1,000 341.2 350 400 500B -$ 2,000 1290 943 300 200

IRR 20%NPVA -$ 0.00 -$ 0.01 NPVB -$ 0.08

Exercise 3 See Net Capital Expenses

Exercise 4Year Cash Flow

0 -10000 11% If IRR>9%, do the project1 50002 40003 3000

Exercise 60 1 2 3 4 5 6

-$4,100 970 970 970 970 970 970-$3,130 -$2,160 -$1,190 -$220 $750 $1,720

Payback Period 4.226804120 1 2 3 4 5 6

-$6,200 970 970 970 970 970 970-$5,230 -$4,260 -$3,290 -$2,320 -$1,350 -$380

Payback Period 6.391752580 1 2 3 4 5 6

-$8,000 970 970 970 970 970 970-$7,030 -$6,060 -$5,090 -$4,120 -$3,150 -$2,180

Payback Period 8.24742268

Exercise 8DCF = [(P - Vcost)*Q - Fcost], (1-tax) + (Tax* depreciation/year)P = 50 Q = 90000 Tax rate = 34% %∆ = 100/150 - 1%Vcost = 45 Fcost = 180000 Depreciation: $450,000/4

Price $50 $50Variable Costs $45 $45Fixed Costs $180,000 $180,000Tax Rate 34% 34%Units Sold 90000 81000Depreciation $112,500 $112,500Years 4 4Capital Cost $450,000 $450,000OCF $216,450 $186,750Percentage Change 3.3 -13.7%

$29,70029700

Year Cash Flow0 -100 28% If IRR>9%, do the project1 502 100

Initial Cost -420000 Discount Rat 10%Capital Cost -30000 Periods 5 YearsAnnual Savings 140000Tax Rate 34%Annual Depreciation -84000Sale Price 60000After-Tax Salvage Va 39600OCF 120960Annuity $458,533.57Capital Future $43,216.12NPV $51,749.69

Exercise 9Initial Cost -$700,000 Base-Case Cash FlowAnnual Depreciation -$87,500.00 8 yearsSales 75000 yearlyPrice/Unit $40Variable Cost/Unit $20Fixed Costs $800,000 yearlyTax Rate 35%Required Return 15%Annuity $2,179,155.51NPV $1,479,155.51

58.3351796

$29,167.5929167.5898

Surer the better; better to get the money back as soon as possible; will still accept if the Payback period is shorter than the cut of the yearsAccept if IRR is larger than reference interest rate ; the larger the better

7 8970 970

$2,690 $3,660

Don't have interest rate, so we can't know when7 8

970 970$590 $1,560

Don't have interest rate, so we can't know when7 8 9 10

970 970 970 970-$1,210 -$240 $730 $1,700

Don't have interest rate, so we can't know when

Base-Case Cash Flow $485,625.00 -$700,000-$87,500.00 8 years

74500 yearly$40$20

$800,000 yearly35%15%

$2,149,987.92$1,449,987.92

Base-Case Cash Flow $479,125.00

baldwin exercise & pset 2 notes

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