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CHAPTER 10 PROBLEMS
CASH FLOWS AND OTHER TOPICS IN CAPITAL BUDGETING
PROBLEM 10-1
CAPITAL GAINS TAX
DATA
Purchase 30,000
Expected life 10
Salvage value 0
Depreciation 3,000
Selling price 35,000
Tax rate 34%
Years from when purch 5
A)
Taxes =
B)
Selling price 25,000
Taxes =
C)
Selling price 15,000
Taxes =
D)
Selling price 12,000
Taxes =
PROBLEM 10-2
RELEVANT CASH FLOWS
DATA
New Sales 25,000,000
Former customers % of sales 20%
Relevant Sales Level
PROBLEM 10-3
CALCULATING FREE CASH FLOWS
DATA
Change in EBIT 475,000
Page 1
Tax rate 34%
Depreciation 100,000
Without
Project With Project Change
Accounts Receivable 45,000 63,000
Inventory 65,000 80,000
Accounts Payable 70,000 94,000
Calculating Free Cash Flows:
Change in EBIT
Less: Change in taxes
Plus: Change in depreciation
Less Change in net working capital
Less: Change in capital spending
Free cash Flows
PROBLEM 10-4
CALCULATING FREE CASH FLOWS
DATA
Change in EBIT 900,000
Tax rate 34%
Depreciation 300,000
Without
Project With Project Change
Accounts Receivable 55,000 63,000
Inventory 55,000 70,000
Accounts Payable 90,000 106,000
Calculating Free Cash Flows:
Change in EBIT
Less: Change in taxes
Plus: Change in depreciation
Less Change in net working capital
Less: Change in capital spending
Free cash Flows
PROBLEM 10-5
CALCULATING OPERATING CASH FLOWS
Page 2
DATA
Revenues 2,000,000
Cash expenses 800,000
Increase in depreciation 200,000
Tax rate 0.34
Net Profit:
Revenues
Cash expenses
Depreciation
EBIT
Tax rate
Net income
Operating Cash Flows:
Change in EBIT
Change in Taxes
Change in depreciation
Operating Cash Flows
PROBLEM 10-6
CALCULATING OPERATING CASH FLOWS
DATA
Revenues 3,000,000
Cash expenses 900,000
Increase in depreciation 400,000
Tax rate 0.34
Net Profit:
Revenues
Cash expenses
Depreciation
EBIT
Tax rate
Net income
Operating Cash Flows:
Change in EBIT
Change in Taxes
Change in depreciation
Operating Cash Flows
Page 3
PROBLEM 10-7
CALCULATING OPERATING CASH FLOWS
DATA
Quantity 10,000
Years 10
Selling price $100 each
Variable costs $40 each
Fixed costs $160,000
Initial expenditure $1,000,000
Salvage value $0
Initial investment in working capital $50,000
Required rate of return 10%
Tax rate 0.34
A)
Initial Outlay
Outflows:
Purchase price
Increased Inventory
Net Initial Outlay
B)
Annual Cash Flows (years 1-9)
Net Income:
Revenues
Cash expenses
Depreciation
EBIT
Tax rate
Net income
Free Cash Flows:
Change in EBIT
Change in taxes
Change in depreciation
Change in net working capital
C)
Page 4
Terminal Cash flow (year 10)
Inflows:
Free Cash flow in year 10
Recapture of working capital
D)
Present Value of Free Cash Flows
Years 1-9
Year 10
Less Initial Cost
Net Present Value
PROBLEM 10-8
CALCULATING OPERATING CASH FLOWS
DATA
Quantity 5,000
Years 5
Selling price $1,000 each
Variable costs $500 each
Fixed costs $1,000,000
Initial expenditure $5,000,000
Salvage value $0
Initial investment in working capital $1,000,000
Required rate of return 10%
Tax rate 0.34
A)
Initial Outlay
Outflows:
Purchase price
Increased Inventory
Net Initial Outlay
B)
Annual Cash Flows (years 1-5)
Net Income:
Revenues
Cash expenses
Page 5
Depreciation
EBIT
Tax rate
Net income
Free Cash Flows:
Change in EBIT
Change in taxes
Change in depreciation
Change in net working capital
C)
Terminal Cash flow (year 5)
Inflows:
Free Cash flow in year 5
Recapture of working capital
D)
Present Value of Free Cash Flows
Years 1-5
Year 5
Less Initial Cost
Net Present Value
PROBLEM 10-9
NEW PROJECT ANALYSIS
DATA
Change in EBIT 35,000
Purchase Price 100,000
Installation Fee 5,000
Increase in Inventory 5,000
Life 10
Salvage Value 0
Depreciation
Tax Rate 34%
Required rate of return 15%
A)
Page 6
Outflows
Purchase Price
Installation Fee
Increased Working Inventory
Net Initial Outlay
B)
Differential Annual Free Cash Flows (Years 1-9)
Cash Flow
Change in EBIT
Change in taxes
Increased Depreciation
Project's Free Cash Flows
C)
Terminal Free Cash Flow (Year 10)
Inflows:
Free Cash Flow in Year 10
Recapture of Working Capital (Inventory)
Total Terminal Cash Flow
D)
Present Value of Free Cash Flows
Years 1-9
Year 10
Less Initial Cost
Net Present Value
PROBLEM 10-10
NEW PROJECT ANALYSIS
DATA
Change in EBIT 150,000
Purchase Price 500,000
Training Session Fee 25,000
Installation Fee 5,000
Increase in Inventory 30,000
Life 10
Salvage Value 0
Depreciation
Page 7
Tax Rate 34%
Required rate of return 15%
A)
Outflows
Purchase Price
Training Session Fee
Installation Fee
Increased Working Inventory
Net Initial Outlay
B)
Differential Annnual Free Cash Flows (Years 1-9)
Cash Flow
Change in EBIT
Change in taxes
Change in depreciation
Project's Free Cash Flows
C)
Terminal Free Cash Flow (Year 10)
Inflows:
Free Cash Flow in Year 10
Recapture of Working Capital (Inventory)
Total Terminal Cash Flow
D)
Present Value of Free Cash Flows
Years 1-9
Year 10
Less Initial Cost
Net Present Value
PROBLEM 10-11
NEW PROJECT ANALYSIS
DATA
Change in EBIT 50,000
Purchase Price 200,000
Training Session Fee 5,000
Page 8
Installation Fee 5,000
Increase in Inventory 20,000
Life 10
Salvage Value 0
Interest payments 8,000
Depreciation
Tax Rate 34%
Required rate of return 10%
A)
Outflows
Purchase Price
Training Session Fee
Installation Fee
Increased Working Inventory
Net Initial Outlay
B)
Differential Annnual Free Cash Flows (Years 1-9)
Cash Flow
Change in EBIT
Change in taxes
Change in depreciation
Project's Free Cash Flows
C)
Terminal Free Cash Flow (Year 10)
Inflows:
Free Cash Flow in Year 10
Recapture of Working Capital (Inventory)
Total Terminal Cash Flow
D)
Present Value of Free Cash Flows
Years 1-9
Year 10
Less Initial Cost
Net Present Value
PROBLEM 10-12
Page 9
COMPREHENSIVE PROBLEM
DATA
Coxt of plant and equipment 14,800,000
Shipping and installation 200,000
Tax rate 34%
Required rate of return 15%
Sales Price per unit (yrs 1-4) 300
Sales Price per unit (yr 5) 250
Variable cost per unit 140
Annual fixed cost 700,000
Depreciation life 5
Section 1: Calculate EBIT
Year 1 2
Units Sold 70,000 120,000
Sales Revenue
Less: Variable Costs
Less: Fixed Costs
Equals: EBDIT
Less: Depreciation
Equals: EBIT
Taxes
Section 2: Calculate Operating Cash Flow
EBIT
Less: Taxes
Plus: Depreciation
Operating Cash Flow
Section 3: Calculate Net Working Capital
Revenue:
Initial Working Capital Requirement
Net Working Capital Needs:
Liquidation of Working Capital
Change in Working Capital:
Section 4: Calculate Free Cash Flow
Operating Cash Flow
Minus: Change in Net Working Capital
Minus: Change in Capital Spending
Page 10
Free Cash Flow:
PV =
NPV
Problem 10-13
COMPREHENSIVE PROBLEM
DATA
Coxt of plant and equipment 6,900,000
Shipping and installation 100,000
Tax rate 34%
Required rate of return 15%
Sales Price per unit (yrs 1-4) 250
Sales Price per unit (yr 5) 200
Variable cost per unit 130
Annual fixed cost 300,000
Depreciation life 5
Section 1: Calculate EBIT
Year 1 2
Units Sold 80,000 100,000
Sales Revenue
Less: Variable Costs
Less: Fixed Costs
Equals: EBDIT
Less: Depreciation
Equals: EBIT
Taxes
Section 2: Calculate Operating Cash Flow
EBIT
Less: Taxes
Plus: Depreciation
Operating Cash Flow
Section 3: Calculate Net Working Capital
Revenue:
Initial Working Capital Requirement
Net Working Capital Needs:
Liquidation of Working Capital
Page 11
Change in Working Capital:
Section 4: Calculate Free Cash Flow
Operating Cash Flow
Minus: Change in Net Working Capital
Minus: Change in Capital Spending
Free Cash Flow:
PV =
NPV
PROBLEM 10-14
RISK-ADJUSTED NPV
Project A Project B
Initial outlay (10,000) (10,000)
Year 1 5,000 6,000
Year 2 5,000 6,000
Year 3 5,000 6,000
Year 4 5,000 6,000
Year 5 5,000 6,000
req. rate of return= 12% 15%
NPVa=
NPVb=
PROBLEM 10-15
RISK-ADJUSTED DISCOUNT RATES AND RISK CLASSES
Project A Project B
Initial outlay (250,000) (400,000)
1 30,000 135,000
2 40,000 135,000
3 50,000 135,000
4 90,000 135,000
5 130,000 135,000
required rate of returns= 12% replacement
15% modification
18% unrelated project
20% r&d
Page 12
NPVa=
NPVb=
MINI CASE
D)
DATA
Coxt of plant and equipment 7,900,000
Shipping and installation 100,000
Tax rate 34%
Required rate of return 15%
Sales Price per unit (yrs 1-4) 300
Sales Price per unit (yr 5) 260
Variable cost per unit 180
Annual fixed cost 200,000
Depreciation life 5
Section 1: Calculate EBIT
Year 1 2
Units Sold 70,000 120,000
Sales Revenue
Less: Variable Costs
Less: Fixed Costs
Equals: EBDIT
Less: Depreciation
Equals: EBIT
Taxes
Section 2: Calculate Operating Cash Flow
EBIT
Less: Taxes
Plus: Depreciation
Operating Cash Flow
Section 3: Calculate Net Working Capital
Revenue:
Initial Working Capital Requirement
Net Working Capital Needs:
Liquidation of Working Capital
Change in Working Capital:
Page 13
Section 4: Calculate Free Cash Flow
Operating Cash Flow
Minus: Change in Net Working Capital
Minus: Change in Capital Spending
Free Cash Flow:
PV =
NPV
IRR =
Page 14
Page 15
Page 16
Page 17
Page 18
Page 19
Page 20
Page 21
Page 22
Page 23
3 4 5
120,000 80,000 70,000
Page 24
3 4 5
120,000 70,000 70,000
Page 25
Page 26
3 4 5
140,000 80,000 60,000
Page 27
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