Capital Budgeting Decisions (Scenario 2) 1) Life Period of the Equipment = 4 years 2) New equipment cost 3) Equipment ship & install cost 4) Related start up cost 5) Inventory increase 6) Accounts Payable increase 7) Equip. salvage value before tax 8) Sales for first year (1) -$200,000 9) Sales increase per year $35,000 10) Operating cost (60% of Sales) -$5,000 (as a percent of sales in Year 1) $25,000 11) Depreciation (Full depreciation) $5,000 12) Marginal Corporate Tax Rate (T) $15,000 13) Cost of Capital (Discount Rate) $200,000 5% -$120,000 -60% -$240,000 21% 10% Year 3 Operations: I/S Revenue Operating Cost Depreciation EBIT Taxes Net Income $200,000 -$120,000 -$240.000 -$160,000 -$33,600 -$126,400 Add back Depreciation $240,000 Total Operating Cash Flow $113,600 $ - - S - S ESTIMATING Initial Outlay (Cash Flow, CFO, T=0) CFO CF1 1 -$200,000 -$35,000 -$5,000 -$240,000 Year Investments: 1) Equipment cost 2) Shipping and Install cost 3) Start up expenses Total Basis Cost (1+2+3) 4) Net Working Capital Increase in CA - Increase in CL Total Initial Outlay Terminal: 1) Change in net WC 2) Salvage value (after tax) Total -$20,000 -$260.000 $ - $ - Salvage Value Before Tax (1-T) $20,000 XXXXX XXXXX $113,600 $ - $. Project Net Cash Flows NPV = -$260,000 IRR = $- Paybacks Q#1 Impact of 2017 Tax Cut Act on Net Income, Cash Flows and Capital Budgeting (Investment ) Decisions Estimate NPV, IRR and Payback period of the project if equipment is fully depreciated in the first year and tax rate equals to 21%. (a) (b) Would you accept the project based on NPV and IRR? (c) Q#2 Would you accept the project based on Payback rule if the project cut-off is 3 yea As a CFO of the firm, which of the Scenarios (1) or (2) would you choose? Why