Problem 1Year ($)

New Cmputer costs $ 1,000,000.00 ITC 15%Orginal cost of Old Computer $ 1,250,000.00 Book Value of Old computer $ 500,000.00 Old Computer can be sold for $ 450,000.00 Cost of Capital 12%Tax rate 35%Loss in Incurred after sale $ 50,000.00 a)Net Investment Required = $ 532,500.00

The write-off is worth $ 17,500.00 This reducres the effective investment in the new machine.

b)Year 0Forcast s net before tax Tax @35%Profit After tax (+) Incremental DepreciationWorking Capital CaptureCash Flow ###

Incremental cash flow = $ 790,000.00

Incremental depreciation calculayion is as below:Cost 1,250,000

5 yr life, SL 250,000

c) If the new computer’s salvage value at the end of five years is projected to be $100,000,

Old Machine D/E per year, 3 yrs

old

should TelCo purchase it? AnswerIf the computer has a salvage value after 5 years, and is sold at that time, the book value will be zero, and the company will have to pay a tax of 0.35 * 100 = $35 at that time.This changes the marginal cash flow in five years to

The present value of the marginal cash flows (at 12%) is $899.19. The net present value is 899.19 - 532.50 = $366.70. therefore, the new computer should be purchased.

1 2 3 4 5 350,000.00 350,000.00 300,000.00 300,000.00 300,000.00

1 2 3 4 5 $ 350,000 $ 350,000 $ 300,000 $ 300,000 $ 300,000

122,500 122,500 105,000 105,000 105,000 227,500 227,500 195,000 195,000 195,000 (50,000) (50,000) (50,000) (50,000) (50,000)

177,500 177,500 145,000 145,000 145,000

$ 1,000,000

Incremental 200,000 (50,000)

c) If the new computer’s salvage value at the end of five years is projected to be $100,000,

New Machine D/E per year

If the computer has a salvage value after 5 years, and is sold at that time, the book value will be zero, and the company will have to pay a tax of 0.35 * 100 = $35 at that time.

330

The present value of the marginal cash flows (at 12%) is $899.19. The net present value is

Problem 3Sales in units 100,000 Unit cost $10 Varico offered to pay/unit $9.50 Interest rate 15%Total cost @ $9.50 per unit $950,000.00Total cost @ $10 per unit ###By buying 100,000 motors today, the firm will have averageinventory on hand of 50,000 during the year 50,000 The opportunity cost of maintaining this inven $ 71,250.00

By buying weekly, the firm incurs no interest expenseThus, the real cost of buying 100,000 motors t ###This exceeds the $1M that it costs to buy motors @ $10 a piece on weekly basistherefore verico should reject the offer.Difference $ (21,250.00)

This exceeds the $1M that it costs to buy motors @ $10 a piece on weekly basis

PROBLEM 4ItemEquipment Cost (0 $1,250 Depreciation 10%Installation cost t $25 Cost of Capital 10%Tax rate 35%Initial cost (000) $875

i) Calculate the net income and operating cash flow using 35%

Year 1 2 3 4Sales (000) 200 1,000 1,150 1,323 COGs (000) 120 600 690 794 Gross Margin (GM) 80 400 460 529 Adv and Gen. Ex (00 10 10 10 10 Depreciation (Equip. $125 $125 $125 $125 Depreciation (Install. $5 $5 $5 $5 EBIT (60) 260 320 389 Tax @ 35% (21) 91 112 136.15 Net Income (39) 169 208 253 OCF 91 299 338 383 PV @ (r = 10%) 83 247 254 261

Tax rate @35% Total $ 2,120

ii) b. Find the net present value of the project using a 10 percent cost of capital.Solution Cost today = $1,844 NPV = $ 276 The Project should be accepted

iii) Under the new cash flow estimates, the project should rejected as indicated below:

Year 1 2 3 4Sales (000) 200 1000 1,150 1,323 COGs (000) 120 600 720 864Adv and Gen. Ex (00 10 11 11 12Depreciation (Equip. $125 $125 $125 $125 Depreciation (Install. $5 $5 $5 $5

EBIT ($60) $260 $289 $317 Tax @ 35% ($21) $91 $101 $111 Net Income ($39) $169 $188 $206 OCF $91 $299 $318 $336 PV @ (r = 10%) $83 247 239 229

Tax rate = 35%Total PV $(000) = $1,760 NPV $(000) = ($84)

i) Calculate the net income and operating cash flow using 35%

5 6 7 8 9 10 1,521 1,749 1,749 1,487 1,264 1,074 913 1,049 1,049 892 758 644 608 700 700 595 505 430 10 10 10 10 10 10

$125 $125 $125 $125 $125 $125 $5 $0 $0 $0 $0 $0

468 565 565 460 370 295 163.92 197.61 197.61 160.88 129.66 103.13 304.43 366.99 366.99 298.78 240.80 191.52 434 492 492 424 366 317 270 278 252 198 155 122

ii) b. Find the net present value of the project using a 10 percent cost of capital.

iii) Under the new cash flow estimates, the project should rejected as indicated below:

5 6 7 8 9 10 1,521 1,749 1,749 1,487 1,264 1,074

1037 1244 1244 1058 899 76412 13 13 14 15 16

$125 $125 $125 $125 $125 $125 $5 $0 $0 $0 $0 $0

$342 $367 $367 $290 $225 $170 $120 $129 $128 $101 $79 $59 $222 $239 $238 $188 $146 $110 $352 $364 $363 $313 $271 $235

219 205 186 146 115 91