1. (Capital gains tax)

The J. Harris Corporation is considering selling one of its old assembly machines. The machine, purchased for $36,000 5 years ago, had an expected life of 12 years and an expected salvage value of zero. Assume Harris uses simplified straight-line depreciation (depreciation of $3,000 per year) and could sell this old machine for $41,000. Also, assume Harris has a 34

percent marginal tax rate.

a. What would be the taxes associated with this sale?

b. If the old machine were sold for $31,000,

what would be the taxes associated with this sale?

c. If the old machine were sold for $21,000, what would be the taxes associated with this sale?

d. If the old machine were sold for $18,000, what would be the taxes associated with this sale?

2. (Calculating free cash flows)

Racin' Scooters is introducing a new product and has an expected change in EBIT of $435,000.

Racin' Scooters has a 33 percent marginal tax rate. Bonus depreciation will be $220,000 in year 1. In addition, the project will cause the following changes in year 1:

	WITHOUT THE PROJECT	WITH THE PROJECT
Accounts receivable	$44,000		$61,000
Inventory	60,000		84,000
Accounts payable	74,000		92,000

What is the project's free cash flow in year 1?

3. (Calculating operating cash flows)

Assume that a new project will annually generate revenues of $2,600,000 for the next 3 years. Cash expenses including both fixed and variable costs will be $600,000 per year, bonus depreciation will be $1,200,000 in year 1, and the firm has enough income in other areas to offset any tax losses that might occur in year 1. In addition, let's assume that the firm's marginal tax rate is 24 percent. Calculate the operating cash flows in years 1 through 3.

4. (Comprehensive problem) The Shome Corporation, a firm in the 22 percent marginal tax bracket with a required rate of return or cost of capital of 17 percent, is considering a new project. The project involves the introduction of a new product. This project is expected to last 5 years and then, because this is somewhat of a fad product, be terminated. Given the following information,

Cost of new plant and equipment	$6,700,000
Shipping and installation costs	$180,000
Unit sales
	YEAR	UNITS SOLD
	1	65,000
	2	120,000
	3	140,000
	4	55,000
	5	55,000
Sales price per unit	$330/unit in years 1 through 4, $280/unit in year 5
Variable cost per unit	$130/unit
Annual fixed costs	$240,000 per year in years 1-5
Working-capital requirements	There will be an initial working-capital requirement of $100,000 just to get production started. For each year, the total investment in net working capital will be equal to 20 percent of the dollar value of sales for that year.Thus, the investment in working capital will increase during years 1 through 3, then decrease in year 4.Finally, all working capital is liquidated at the termination of the project at the end of year 5.
Depreciation method	Bonus depreciation method, and as a result the bonus depreciation occurs in year 1, with no depreciation in any other years. If any losses occur, they would be offset by profits in other areas of the company.

determine the free cash flows associated with the project, the project's net present value, the profitability index, and the internal rate of return. Apply the appropriate decision criteria.

5. (Real options and capital budgeting)

You have come up with a great idea for a Tex-Mex-Thai fusion restaurant. After doing a financial analysis of this venture, you estimate that the initial outlay will be $5.6 million. You also estimate that there is a 50 percent chance that this new restaurant will be well received and will produce annual cash flows of $820,000 per year forever (a perpetuity), while there is a 50 percent chance of it producing a cash flow of only $200,000 per year forever (a perpetuity) if it isn't received well.

a. What is the NPV of the restaurant if the required rate of return you use to discount the project cash flows is 11 percent?

b. What are the real options that this analysis may be ignoring?

c. Explain why the project may be worthwhile even though you have just estimated that its NPV is negative?