Question

Fresno Furniture Manufacturing Inc. currently earns annual revenues of $850,000 and incurs total operating expenses (excluding depreciation and interest expense) of 40.00% of revenues. Its earnings are taxed at a rate of 40%. Today, its budgeting committee is evaluating the purchase of a new lathe. The lathe is expected to cost $80,000, plus $4,000 in freight and setup expenses, and will be depreciated using straight-line depreciation. It is expected that the lathe will have a useful life of five years and a salvage value equal to 25.00% of its purchase price of $80,000. It is expected that the lathe will be sold for its book value, such that no capital gain or loss will be realized. It is further expected that the lathe will cause a 25.00% increase in the firm's annual sales and total operating expenses (excluding depreciation and interest expense). If the lathe is purchased, the firm will require an additional $10,000 in net working capital (NWC). Given this information, complete the following analysis: Question Answer What is the annual depreciation expense for the lathe? What is the net investment (NINV) of the investment? What are the net annual operating after-tax cash flows associated with this project? What is the project's last year (terminal) cash flow?

Answer 1

Annual depreciation expense = (Purchase cost + Set up cost - salvage value) / Life = (80,000 + 4,000 - 25% x 80,000) / 5 = $ 12,800

Net investment = Purchase cost + Set up cost + working capital investment = 80,000 + 4,000 + 10,000 = $ 94,000

Net annual operating cash flows = [Sales x (1 + expected growth rate) x (1 - cost %age) - Annual depreciation] x (1 - tax rate) + Annual depreciation = [85,0000 x (1 + 25%) x (1 - 40%) - 12,800) x (1 - 40%) + 12,800 = $  387,620

Terminal cash flow = salvage value + recapture of working capital = 25% x 80,000 + 10,000 = $ 30,000