Question

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12. The Lumber Yard is considering adding a new product line that is expected to increase annual sale:s by $238,000 and cash expenses by S that will be depreciated using the straight-line method to a zero book value over the 6-year life of the project. The company has a marginal tax rate of 32 percent. What is the annual value of the depreciation tax shield? 184,000. The initial investment will require $96,000 in fixed assets (a) $5,120 (b) $5,888 (c) $16,000 (d) $30,720 13. Jasper Metals is considering installing a new molding machine which is expected to produce operating cash flows of $73,000 a year for 7 years. At the beginning of the project, inventory will decrease by $16,000, accounts receivables will increase by $21,000, and accounts payable will increase by $15,000 All net working capital will be recovered at the end of the project. The initial cost of the molding machine is $249,000. The equipment will be depreciated straight-line to a zero book value over the life of the project. The equipment will be salvaged at the end of the project creating a $48,000 aftertax cash flow. At the end of the project, net working capital will return to its normal level. What is the net present value of this project given a required return of 14.5 percent? (a) $79,418.80 (b) $82,336.01 (c) $84,049.74 (d) $87,925.54 14. Gateway Communications is considering a project with an initial fixed asset cost of $2.46 million which will be depreciated straight-line to a zero book value over the 10-year life of the project. At the end of the project the equipment will be sold for an estimated S300,000. The project will not directly produce any sales but will reduce operating costs by $725,000 a year. The tax rate is 35 percent. The project will immediately require $45,000 of inventory which will be recouped when the project ends. Should this project be implemented if the firm requires a 14 percent rate of return? Why or why not? (a) No; The NPV is -$172,937.49 (b) No; The NPV is -$87,820.48 (c) Yes; The NPV is $387,516.67 (d) Yes; The NPV is $466,940.57

Answer 1

12) a)$5120

Depreciation = Cost of asset less salvage value/ Useful life

=96000-0 /6

=96000/6

=16000$

Tax shield on depreciation = depreciation*tax rate

=16000*32%

=5120$

13) C) $84049.74

Statement showing NPV

Particulars	0	1	2	3	4	5	6	7	Total(NPV)
Cost of molding Machine	-249000
WC requirement (16000-21000+15000)	10000
Operating cash flow		73000	73000	73000	73000	73000	73000	73000
Salvage value								48000
WC returned to normal level								-10000
Cash flow	-239000	73000	73000	73000	73000	73000	73000	111000
PVIF @ 14.5%	1	0.87	0.76	0.67	0.58	0.51	0.44	0.39
Present value	-239000.00	63755.46	55681.62	48630.24	42471.82	37093.30	32395.89	43021.40	84049.74

WC requirement =

Inventory has decreased by $16000 hence cash will increased by $16000

Account receivables has increased by $21000 hence cash will decreased by $21000

Account payables has increased by $15000 hence cash will increased by $15000

14) d) yes , The NPV is $466,940.57

Particulars	0	1	2	3	4	5	6	7	8	9	10	NPV
Cost of molding Machine	-2460000
WC requirement	-45000
Savings in operating cost		725000	725000	725000	725000	725000	725000	725000	725000	725000	725000
Depreciation		-246000	-246000	-246000	-246000	-246000	-246000	-246000	-246000	-246000	-246000
PBT		479000	479000	479000	479000	479000	479000	479000	479000	479000	479000
Tax @35%		167650	167650	167650	167650	167650	167650	167650	167650	167650	167650
PAT		311350.00	311350.00	311350.00	311350.00	311350.00	311350.00	311350.00	311350.00	311350.00	311350.00
Add: Depreciation		246000.00	246000.00	246000.00	246000.00	246000.00	246000.00	246000.00	246000.00	246000.00	246000.00
Annual cash flow		557350.00	557350.00	557350.00	557350.00	557350.00	557350.00	557350.00	557350.00	557350.00	557350.00
Salvage value( 300000-35%)											195000
WC recovered											45000
Cash flow	-2505000	557350.00	557350.00	557350.00	557350.00	557350.00	557350.00	557350.00	557350.00	557350.00	797350.00
PVIF @14%	1.00	0.88	0.77	0.67	0.59	0.52	0.46	0.40	0.35	0.31	0.27
Present value	-2505000.00	488903.51	428862.73	376195.37	329995.94	289470.13	253921.16	222737.86	195384.09	171389.55	215080.23	466940.57