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CHAPTER 11.Cash Flows and Other Topics in Capita 9 403 We are considering the introduction of a new product. Currently we are in the 34 percent marginal tax bracket with a 15 percent required rate of return or cost of capital. This project is expected to last 5 years and then, because this is some- what of a fad product, be terminated. The following information describes the new project: Cost of new plant and equipment Shipping and installation costs $7,900,000 100,000 UNIT SALES YEAR UNITS SOLD 70,000 120,000 140,000 80,000 60,000 Sales price per unit Variable cost per unit Annual fixed costs Working-capital requirements $300 unit in years 1 through 4, $260 unit in year 5 $180/unit $200,000 per year in years 1-5 There will be an initial working-capital requirement of $100,000 just to get production started. For each year, the total investment in net working capital will be equal to 10 percent of the dollar value of sales for that year. Thus, the investment in working capi- tal will increase during years 1 through 3, then decrease in year 4 Finally, all working capital is liquidated at the termination of the project at the end of year 5. Depreciation method Use the simplified straight-line method over 5 years. Assume that the plant and equipment will have no salvage value after 5 years. a. Should Caledonia focus on cash flows or accounting profits in making its capital-budgeting decisions? Should the company be interested in incremental cash flows, incremental profits, total free cash flows, or total profits? b. How does depreciation affect free cash flows? c. How do sunk costs affect the determination of cash flows? d. What is the project's initial outlay? e. What are the differential cash flows over the project's life? f. What is the terminal cash flow? g. Draw a cash flow diagram for this project. h. What is its net present value? i. What is its internal rate of return? i. Should the project be accepted? Why or why k. In capital budgeting, risk can be measured from three perspectives. What are not? those three measures of a project's risk? 1. According to the CAPM, which measurement of a project's risk is relevant? What complications does reality introduce into the CAPM view of risk, and what does that mean for our view of the relevant measure of a project's risk? m.Explain how simulation works. What is the value in using a simulation approach? n. What is sensitivity analysis, and what is its purpose