Question

SECTION II (Answer one questions in this section - 15pt.) 5. A project requires an initial investment of $200,000, has a four-year life and is depreciated straight-line to zero. The firm is in the 34% marginal tax bracket One project-relevant information are provided below. Unit Sale=7,000 ; Price/unit=$125.00, Variable Cost = $105.00, Fixed Costs = $90,000 a. Calculate the annual Operating Cash Flow. Show your computations clearly. (15 p.? D. IT the required return for the proiect is 7%, should the firm undertake it under this scenario, using the NPV criterion? (7 pt.)

Answer 1

Given : Initial Investment Life Tax rate required return Unit Sale Price/unit Variable Cost Fixed Cost 200000 $ 4 years 34% 7% 7000 125 $ 105 $ 90000 $ Solution:- Part a: Annual operating cashflow Step1 : Calculate Depriciation Depriciation Cost Life 200000 50000 Step 2: Calculation of Annual operating Cash Flow Year Unit Profit/U Profit Dep. FC NCF CFADT CFAT 7000 7000 7000 7000 PWN 20 20 20 20 140000 140000 140000 140000 50000 50000 50000 50000 90000 10 900000 900000 90000 0 CESP CFC -200000 -200000 50000 50000 50000 50000 50000 50000 50000 50000 0 0 0 Where, Profit / Unit Profit Depreciation (Dep.) = NCF (Net Cash Flow) CFADT (Cash flow after Dep. & Tax) = CFAT (Cash flow after Tax) = CFSP= CFC (Annual operating cash flow) Selling Price per unit - Variable Cost per unit No. of units X Profit / Unit Fictional Cash Flow (Used on for Tax Calulation) Annual fixed cost Profit - Dep. - FC NCFX (1 - Tax Rate) CFAT + Depreciation Cash Flow due to Sale / Purchase of Asset CFAT +CFSP Part b: Calculation of Net Present Vale (NPV) Year 0 1 CFC TPVE TPV -200000| 1 -200000 500001 0.935 46728.97 500001 0.873 43671.94 500001 0.816 | 40814.89 5 00001 0.763 38144.76 NPV -30639.44 3 4 (1/(1+r)^n Where PVF (Present Value Factor) = where r is Discount Rate and n is Number of year PV (Present Value) = CFC X PVF As the NPV of the project is -30639.44 $ the firm should not undertake it under this scenario.