Financial Management

Chapter 11 Case

1. CompU is looking at starting a major advertising campaign to further expand their business. Based on preliminary estimates, the advertising campaign will cost $100,000 and will increase revenue by $80,000 per year for the next 5 years. The increased expenses excluding depreciation will be $35,000 per year. Inventory will increase by $25,000, accounts receivable will increase by $20,000, accounts payable will increase by $20,000, and accruals will increase by $15,000. The company is in the 40% tax bracket. The ad campaign will be capitalized and depreciated using a 5-year MACRS recovery schedule.

1. Calculate the initial investment associated with the advertising campaign.
2. Calculate the annual operating cash flows for the project.

2. CellU, a subsidiary of CompU, is looking to replace one of the machines they use to manufacture cell phones with a new, more efficient model. The current machine cost $7,500, is three years old, and is depreciated using the MACRS 3-year recovery period. The current machine could be sold now for $1,000, but at the end of 3 years it would be worthless. The cost of the new machine is $11,500, installation costs are $500, and would require an increase in net working capital of $1,000. The expected life of the new machine is 3 years, is depreciated using the MACRS 3-year recovery period, and will reduce annual labor expenses from $10,000 to $4,000. At the end of the project the firm will be able to sell the new machine for $3,000 and recover their investment in net working capital. The firm has a marginal tax rate of 40 percent.

1. Calculate the initial investment of the new machine.
2. Calculate the annual incremental operating cash flows for the new machine.
3. Calculate the terminal value of the new machine.