Capital Budgeting

The Calpine firm is evaluating the purchase of a Theatre, the Dome. The Theatre would cost Calpine $1 million and would be depreciated for tax purposes using straight-line over 20 years (that is, $50,000 per year). It is expected that the Theatre will increase Calpine revenues by $400,000 per year, but would also increase expenses by $200,000 per year. Calpine would be expected to increase its working capital by $20,000 to accommodate the increased investment in ticket accounts receivable. Calpine firm intends to sell the Theatre to the city after ten years for $600,000. The marginal tax rate for Calpine is 35%. For purposes of identifying the timing of cash flows, consider the purchase to be made at the end of 2010, the first year of operations the year 2011, and the last year of operations the year 2020.

a.What are the cash flows related to the acquisition of the Theatre?

b.What are the cash flows related to the disposition of the Theatre?

c.Calculate the net cash flows for each year, 2010 through 2020.

d.If the cost of capital for this project is 10%, should Calpine invest in the new Theatre?

e.Draw an investment profile of the project. Over what range of cost of capital would this project be attractive? Over what range of cost of capital would this project be unattractive?