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Cash Flow Estimation Question 1 (Answer: $ 544) : PAF - Karachi Institute of Economics and Technology Class ID: 110217

This document contains 6 questions regarding cash flow estimation and net present value (NPV) calculations for various capital investment projects. Information such as project costs, salvage values, revenues, expenses, tax rates, and discount rates are provided. Students are asked to calculate the NPV for each project based on the given cash flow information.

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Zaka Hassan
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66 views

Cash Flow Estimation Question 1 (Answer: $ 544) : PAF - Karachi Institute of Economics and Technology Class ID: 110217

This document contains 6 questions regarding cash flow estimation and net present value (NPV) calculations for various capital investment projects. Information such as project costs, salvage values, revenues, expenses, tax rates, and discount rates are provided. Students are asked to calculate the NPV for each project based on the given cash flow information.

Uploaded by

Zaka Hassan
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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PAF – Karachi Institute of Economics and Technology

Course: Financial Management


Faculty: Ali Sajid
Class ID: 110217 Total Marks:
Examination: Assignment #2 Date:
Student Name: ID:

Cash flow Estimation

Question 1 (Answer: $ 544)

Given the following information, calculate the NPV of a proposed project: Cost = $4,000; estimated life = 3
years; initial decrease in accounts receivable = $1,000, which must be restored at the end of the project’s
life; estimated salvage value = $1,000; earnings before taxes and depreciation = $2,000 per year; tax rate =
40 percent; and cost of capital = 18 percent. The applicable depreciation rates are 33 percent, 45 percent,
15 percent, and 7 percent

Question 2 (Answer: -$21,493)

Mars Inc. is considering the purchase of a new machine that will reduce manufacturing costs by $5,000
annually. Mars will use the MACRS accelerated method to depreciate the machine, and it expects to sell
the machine at the end of its 5-year operating life for $10,000. The firm expects to be able to reduce net
operating working capital by $15,000 when the machine is installed, but required net operating working
capital will return to its original level when the machine is sold after 5 years. Mars’ marginal tax rate is 40
percent, and it uses a 12 percent cost of capital to evaluate projects of this nature. The applicable
depreciation rates are 20 percent, 32 percent, 19 percent, 12 percent, 11 percent, and 6 percent. If the
machine costs $60,000, what is the project’s NPV?

Question 3 (Answer: $2,292)

Stanton Inc. is considering the purchase of a new machine that will reduce manufacturing costs by $5,000
annually and increase earnings before depreciation and taxes by $6,000 annually. Stanton will use the
MACRS method to depreciate the machine, and it expects to sell the machine at the end of its 5-year
operating life for $10,000 before taxes. Stanton’s marginal tax rate is 40 percent, and it uses a 9 percent
cost of capital to evaluate projects of this type. The applicable depreciation rates are 20 percent, 32
percent, 19 percent, 12 percent, 11 percent, and 6 percent. If the machine’s cost is $40,000, what is the
project’s NPV?
Question 4 (Answer: -$1,756,929)

MacDonald Publishing is considering entering a new line of business. In analyzing the potential business,
their financial staff has accumulated the following information:

 The new business will require a capital expenditure of $5 million at t = 0. This expenditure will be
used to purchase new equipment.
 This equipment will be depreciated according to the following depreciation schedule:

Year MACRS Depreciation Rates

1 0.33

2 0.45

3 0.15

4 0.07

 The equipment will have no salvage value after four years.


 If MacDonald goes ahead with the new business, inventories will rise by $500,000 at t = 0, and its
accounts payable will rise by $200,000 at t = 0. This increase in net operating working capital will be
recovered at t = 4.
 The new business is expected to have an economic life of four years. The business is expected to
generate sales of $3 million at t = 1, $4 million at t = 2, $5 million at t = 3, and $2 million at t = 4.
Each year, operating costs excluding depreciation are expected to be 75 percent of sales.
 The company’s tax rate is 40 percent.
 The company’s weighted average cost of capital is 10 percent.
 The company is very profitable, so any accounting losses on this project can be used to reduce the
company’s overall tax burden.

What is the expected net present value (NPV) of the new business?

Question 5 (Answer: $ 7.89)

Your company is considering a machine that will cost $1,000 at Time 0 and can be sold after 3 years for
$100. To operate the machine, $200 must be invested at Time 0 in inventories; these funds will be
recovered when the machine is retired at the end of Year 3. The machine will produce sales revenues of
$900 per year for 3 years and variable operating costs (excluding depreciation) will be 50 percent of sales.
Operating cash inflows will begin 1 year from today (at Time 1). The machine will have depreciation
expenses of $500, $300, and $200 in Years 1, 2, and 3, respectively. The company has a 40 percent tax rate,
enough taxable income from other assets to enable it to get a tax refund from this project if the project’s
income is negative, and a 10 percent cost of capital. Inflation is zero. What is the project’s NPV?

Question 6 (Answer: $1.01 million)

Buckeye Books is considering opening a new production facility in Toledo, Ohio. In deciding whether to
proceed with the project, the company has accumulated the following information:

 The estimated up-front cost of constructing the facility at t = 0 is $10 million. For tax purposes the
facility will be depreciated on a straight-line basis over 5 years.
 The company plans to operate the facility for 4 years. It estimates today that the facility’s salvage
value at t = 4 will be $3 million.
 If the facility is opened, Buckeye will have to increase its inventory by $2 million at t = 0. In addition,
its accounts payable will increase by $1 million at t = 0. The company’s net operating working
capital will be recovered at t = 4.
 If the facility is opened, it will increase the company’s sales by $7 million each year for the 4 years
that it will be operated (t = 1, 2, 3, and 4).
 The operating costs (excluding depreciation) are expected to equal $3 million a year.
 The company’s tax rate is 40 percent.
 The project’s cost of capital is 12 percent.

What is the project’s net present value (NPV)?

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