Capital Budgeting Decisions (Scenario 2) 1) Life Period of the Equipment = 4 years 8) Sales for rst year (1) $ 200,000 2) New equipment cost $ (200,000) 9) Sales increase per year 5% 3) Equipment ship & install cost S (35,000) 10) Operating cost (60% of Sales) 5 (120,000) 4) Related start up cost $ (5,000) (as a percent of sales in Year 1) -60% 5) inventory increase 5 25,000 1 1) Depreciation (Full depreciation) 5 (240,000) 6) Accounts Payable increase 5 5,000 12) Marginal Corporate Tax Rate (1') 21% 7) Equip. salvage value before tax $ 15,000 13) Cost of Capital (Discount Rate) 10% Year 1 2 E 4. Operations: lIS Revenue $ 200,000 Operating Cost $ (120,000) Depreciation $ (240,000) EBIT $ (160,000) Taxes $ (33,600) Net Income $ (126,400) Add back Depreciation $ 240,000 Total Operating Cash Flow $ 113,600 $ - $ - $ - ESTIMATING Initial Outlay (Cash Flow, CFO, T= 0) CFO CF1 CF2 CF3 CF4 Year 0 1 2 3 4 Investments: 1) Equipment cost $ (200,000) 2) Shipping and Install cost $ (35,000) 3) Start up expenses $ (5,000) Total Basis Cost (1+2+3) $ (240,000) 4) Net Working Capital Increase in CA - Increase in CL $ (20,000) Total Initial Outlay $ (260,000) Terminal: 1) Change in net WC $ $ $ $ 20,000 2) Salvage value (after tax) Salvage Value Before Tax (1-T) XXXXX Total XXXXX Project Net Cash Flows $ (260,000) $ 113,600 $ - $ $ NPV = IRR = Payback=Q#1 Impact of 2017 Tax Cut Act on Net Income, Cash Flows and Capital Budgeting (Investment ) Decisions (3) Estimate NPV, IRR and Payback Period of the project if equipment is fully depreciated in the first year and tax rate equals to 21%. (b) Would you accept the project based on NPV and IRR? (c ) Would you accept the project based on Payback rule if the project cut-off is 3 years? Q#2 As a CFO of the rm, which of the Scenarios (1) or(2) would you choose? Why