1. Ch 11 &12 Capital Budgeting

2. Problem #1
1. Anderson Systems is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that if a project's projected NPV is negative, it should be rejected.
WACC: %
Year
Cash flows -$1,000 $500 $500 $500

3. Problem #1
Problem #1

4. Problem #2
2. Taggart Inc. is considering a project that has the following cash flow data. What is the project's payback?
Year
Cash flows -$1,150 $500 $500 $500

5. Problem #2
2.30 years
/500= 2.3 YEARS

6. Payback
Example
Examine the three projects and note the mistake we would make if we insisted on only taking projects with a payback period of 2 years or less.

7. Problem #3
3. Simms Corp. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC or negative, in both cases it will be rejected.

8. Problem #3
Year
Cash flows -$1,000$425 $425 $425

9. Problem #4
As a member of GOLD Corporation's financial staff, you must estimate the Year 1 operating net cash flow for a proposed project with the following data.  What is the Year 1 operating cash flow?
      Sales $66,000
      Depreciation                   $20,000
      Other operating costs       $34,000
      Interest expense                $8,000
      Tax rate                           35%

10. Problem #4
Sales Revenue                                                 $66,000 Operating costs(x-depr)                                 $34,000 Depreciation expense                                      $20,000 ____________________________________________ Operating income (EBIT)                                $12,000 -Taxes                                                                -$4,200 ____________________________________________ After-tax EBIT                                                  $7,800 + Depreciation                                                   $20,000 ____________________________________________ Operating cash flow                                           $27,800

11. Problem #5
DelL Software is considering a new project whose data are shown below. The equipment that would be used has a 5-year tax life, after which it will be worthless, and it will be depreciated by the straight line method over 5 years. Revenues and other operating costs are expected to be constant over the project's 5-year life.  What is the project's operating cash flow during Year 1?
      Equipment cost (depreciable basis)       $100,000
      Straight line depreciation rate           %
      Sales $150,000
      Operating costs excl. depr’n              $50,000
      Tax rate                                     %

12. Problem #5
Sales Revenues                                          $150,000 -Operating costs (x-depr)                           -$50,000 -Basis x rate = depreciation =                     -$20,000                                                                   Operating income (EBIT)                             $80,000 -Taxes                                                           -$ 40,000                                                                    After-tax EBIT                                             $40,000 +Depreciation                                               $20,000 __________________________________________ Operating cash flow, Year 1                         $60,000 

13. Problem #6
Ahwanee Resorts is considering a new project whose data are shown below. 
The equipment that would be used has a 3-year tax life, would be depreciated by the straight line method over the project's 3 year life, and would have zero salvage value. 
No new working capital would be required. Revenues and other operating costs are expected to be constant over the project's 3-year life.  What is the project's NPV?
(Hint: Cash flows are constant in Years 1-3.)
      WACC  %
      Net investment cost (depreciable basis)        $100,000
      Straight line depr™n rate                        %
      Sales revenues                                  $200,000
      Operating costs excl. depr™n                    $60,000
      Tax rate                                            %

14. Problem #6
Solution:

15. Problem #7
7.Big DIG Services is now in the final year of a project.  The equipment originally cost $2 million, of which 50% has been depreciated.  Big DIG can sell the used equipment today for $1.2 million, and its tax rate is 50%.  What is the equipment’s after-tax net salvage value?

16. Problem #7
Equipment cost                                                    $2,000,000 -Accumulated depr'n                                            $1,000,000 Current BV of equipment                                      1,000,000 Market value                                                          $1,200,000 Gain(loss) on sale of equip                                    $200,000 Taxes paid (credited)                                              100,000
After-tax net salvage value                                      100,000

17. Problem #8
You work for Beta Inc., and you must estimate the Year 1 operating net cash flow for a proposed project with the following data.  What is the Year 1 operating cash flow?
      Sales $42,000
      Depreciation                    $8,000
      Other operating costs     $12,000
      Tax rate                            50%

18. Problem #8
Sales revenues                       $42,000 -Operating costs (x-depr)    $12,000 -Depreciation expense          $8,000                                             Operating income (EBIT)     $22,000 -Taxes                                      $ 11,000 After-tax EBIT                        $11,000 + Depreciation                         $8,000 Operating cash flow              $19,000