2. Shrieves Casting Company is considering adding a new line to its
product mix and the capital budgeting analysis is being conducted. The
production line would be set up in usued space in Shrieves’ main plant.
The machinery’s invoice price would be approximately $220,000, another
$10,000 in shipping charges would be required, and it would cost an
additional $30,000 to install the equipment.
The machinery has an economic life of 4 years and the accelerated
depreciation rates are as follows: Year 1: 33%,.Year 2: 45%, Year 3: 15%,
Year 4: 7%. The machinery is expected to have a salvage value of $50,000
after 4 years of use.
The new line would generate incremental sales of 1,500 units per year for
4 years at an incremental cost of $100 per unit in the first year, excluding
depreciation.
Each unit can be sold for $200 in the first year.
The sales price and cost are expected to increase by 5% per year due to
inflation.
Further, to handle the new line, the firm’s net working capital would
have to increase by an amount equal to 20% of sales revenues.
The firm’s tax rate is 40%, and its overall weighted average cost of capital
is 10%.
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3. A. What is the machinery’s depreciable cost basis ?
What are the annual depreciation expenses ?
Depreciation Basis: Cost + Shipping + Installation
Basis = Cost ( $220,000)
+ Shipping ( $10,000)
+ Installation ( $30,000)
= $260,000
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4. What are the annual depreciation expenses ?
Annual Depreciation Expense
Year % (Inıtıal Basis) =Depreciation
1 33% * $260,000 $85.8
2 45% * $260,000 $117
3 15% * $260,000 $39
4 7% * $260,000 $18.2
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5. B. Calculate the annual sales revenues and costs.
Annual Sales and Costs ( 5% inflation is assumed )
Year 1 Year 2 Year 3 Year 4
Units Quantity 1500 1500 1500 1500
Unit Selling price $200 $210 $220,5 $231,52
Unit Cost $100 $105 $110,25 $115,76
Sales $300000 $315000 $330750 $347280
Costs $150000 $157500 $165375 $173640
Revenue $150000 $157500 $165375 $173640
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6. Why is it important to include inflation when
estimating revenues and costs ?
Nominal r > real r. The cost of capital, r, includes a premium for
inflation.
Nominal CF > real CF. This is because inflation.
If you discount real CF with the higher nominal r, then your NPV
estimate would be too low.
Nominal CF should be discounted with nominal r and real CF
should be discountes with real r.
It is more realistic to find the nominal CF than it is to reduce the
nominal r to a real r. 6
7. C. Calculate the annual operating cash flows of the
investment
Year 1 Year 2 Year 3 Year 4
Sales $300,000 $315,000 $330,750 $347,280
Cost $150,000 $157,500 $165,375 $173,640
Deprec. $85,800 $117,000 $39,000 $18,200
EBIT $64,200 $40,500 $126,375 $155,440
Taxes(40%) $25,680 $16,200 $50,500 $62,176
EBIT(1-T) $38,520 $24,300 $75,825 $93,264
+Deprec. $85,800 $117,000 $39,000 $18,200
Net Op. CF $124,320 $141,300 $114,825 $111,464
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8. D. Estimate the required net working capital for each
year
Net Working Capital For Each Year
Year Sales NWC (%20) CF Due To Inv. In NWC
•0 - 60,000 -60,000
•1 300,000 63,000 -3000
•2 315,000 66,150 -3150
•3 330,750 69,456 -3300
•4 347,280 0 -69,456
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9. E. Calculate the after-tax salvage cash flow
Salvage Cash Flow
Salvage Value 50,000
Book Value 0
Gain 50,000
Tax on SV(0.4) 20,000
Net Terminal Cash Flow 30,000
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10. F. Calculating net cash flows and NVP
Year 0 Year 1 Year 2 Year 3 Year 4
Initial Cost -$300,000 0 0 0 0
Operational CF 0 $124,320 $141,300 $114,825 $111,464
NWC CF -$60,000 -$3,000 -$3,150 -$3,300 -$69,456
Salvage CF 0 0 0 0 $30,000
Net Cash Flow -$320,000 $121,320 $138,150 $111,525 $72,008
0 1 2 3 4
NPV = $37,437 > $0
-$320,000 $121,320 $138,150 $111,525 $72,008
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