1. Siclan Company Problem

The Siclan Company is considering opening a new office. The company owns the building and would sell it for $74,000 after taxes if it does not open the new office. The building has been depreciated down to a zero book value. The equipment that will be used in the building costs $69,000. The equipment that would be used has a 3 year tax life, depreciated straight-line, with 0 scrap value. (If the company tried to sell the equipment at end of year 3, it would receive 0 sales proceeds). (There will be no new revenues after the end of year 3.) No new working capital is required.

WACC = 15%

Due to opening the office and using the equipment, additional annual Revenues = $100,000

Additional annual Operating cost, excluding depreciation = $20,000

Tax rate = 30%

What is the required cash outflow associated with the acquisition of a new machine at t = 0?

What is the projects NPV?

Rework the same problem for Siclan company using MACRS depreciation method instead of straight line depreciation. The equipment that would be used has a 3 year tax life, depreciated using MACRS, with a 0 salvage value. No new working capital is required. What is the project NPV?

First determine the amount of depreciation each year. Use the depreciation percentages in Table A.1, the Appendix to Chapter 9.

For this problem and for the examples that we cover in the asynchronous and synchronous sessions, we will assume that the company puts the equipment into use in year 0 of the project. The textbook on p. 298 states, The table indicates the percentage of the assets cost that may be depreciated each year, with year 1 indicating the year the asset was first put into use (typically year 0 in your spreadsheet as in Example 9.8. For the My Finance Lab Homework and Quiz problems, assume that the equipment is put into use in year 0, as the textbook indicates.

Remember that Equipment with a 3-year tax life is depreciated over 4 calendar years under MACRS (due to the MACRS -year convention).

Note: If you scrap the equipment after 3 years, then you would get a tax reduction due to the fact that you had not fully depreciated the machine before you scrapped it.

2. Buckeye Books - another Capital Budgeting Problem

Buckeye Books is considering opening a new production facility in Toledo, Ohio. The firm uses free cash flow discounted by the cost of capital. The firm has the following information:

The up-front cost of the facility at t=0 is $10 million. The facility will be depreciated on a straight line basis to 0 over 5 years. (The facility will not be used again after the fifth year.)

The company will operate the facility for 5 years. It can be sold for $3 million at t=5.

Interest expense will increase by $50,000/year with this project.

The firm spent $750,000 on a feasibility study a year and a half ago. The study concluded that opening a new facility would be profitable.

If the facility is opened, Buckeye will need additional inventory at t=0 of $2 million. Accounts payable will increase by $1 million at t=0. All working capital will be recovered at t=5.

If the facility is opened, it will increase sales by $7 million/year in year 1 and costs will increase by $3 million/year. Inflation is expected to be 4%/year for the life of the project. Inflation will not impact year 1 revenues and costs, but will impact revenues and costs in years 2-5.

The tax rate is 40%.

If the project is not done, the land on which the facility would be built will be sold for $5 million immediately.

Compute the cash flows for years 0, 1, 5 (You can compute the cash flows for years 2, 3, 4, also, if you wish.) If you have computed the cash flows for all years 0-5, then you can find the IRR and MIRR. You can also find the NPV, if we give you a required return (WACC).

In class let us find the NPV at 10% and 5%. You can prepare to calculate the NPV, but you do not need to turn in the calculation of NPV.