NPV

A project has an initial cost of $59,900, expected net cash inflows of $11,000 per year for 8 years, and a cost of capital of 8%. What is the project's NPV? Construct a time line.

NPVs, IRRs, and MIRRs for Independent Projects

Edelman Engineering is considering including two pieces of equipment, a truck and an overhead pulley system, in this year's capital budget. The projects are independent. The cash outlay for the truck is $15,000 and that for the pulley system is $21,000. The firm's cost of capital is 11%. After-tax cash flows, including depreciation, are as follows:

Year Truck Pulley

1 $5,100 $7,500

2 5,100 7,500

3 5,100 7,500

4 5,100 7,500

5 5,100 7,500

a.Calculate the IRR for each project.

Truck:%

What is the correct accept/reject decision for this project?

Pulley:%

What is the correct accept/reject decision for this project?

b.Calculate the NPV for each project.

Truck: $

What is the correct accept/reject decision for this project?

Pulley: $

What is the correct accept/reject decision for this project?

c.Calculate the MIRR for each project.

Truck:%

What is the correct accept/reject decision for this project?

Pulley:%

What is the correct accept/reject decision for this project?

NPVs and IRRs for Mutually Exclusive Projects

Davis Industries must choose between a gas-powered and an electric-powered forklift truck for moving materials in its factory. Because both forklifts perform the same function, the firm will choose only one. (They are mutually exclusive investments.) The electric-powered truck will cost more, but it will be less expensive to operate; it will cost $21,500, whereas the gas-powered truck will cost $17,960. The cost of capital that applies to both investments is 13%. The life for both types of truck is estimated to be 6 years, during which time the net cash flows for the electric-powered truck will be $6,860 per year and those for the gas-powered truck will be $4,600 per year. Annual net cash flows include depreciation expenses.

a.Calculate the NPV for each type of truck.

Electric-powered truck

$

Gas-powered truck

$

b.Calculate the IRR for each type of truck.

Electric-powered truck

%

Gas-powered truck

%

c.Which type of the truck should the firm purchase?

Capital Budgeting Methods

Project S has a cost of $11,000 and is expected to produce benefits (cash flows) of $3,400 per year for 5 years. Project L costs $23,000 and is expected to produce cash flows of $6,900 per year for 5 years.

a.Calculate the two projects' NPVs, assuming a cost of capital of 14%. Round your answers to the nearest cent.

Project S

$

Project L

$

b.Which project would be selected, assuming they are mutually exclusive?

c.Calculate the two projects' IRRs. Round your answers to two decimal places.

Project S

%

Project L

%

d.Which project would be selected, assuming they are mutually exclusive?

e.Calculate the two projects' MIRRs, assuming a cost of capital of 14%. Round your answers to two decimal places.

Project S

%

Project L

%

f.Which project would be selected, assuming they are mutually exclusive?

g.Calculate the two projects' PIs, assuming a cost of capital of 14%.

Project S

Project L

h.Which project would be selected, assuming they are mutually exclusive?

i.Which project should actually be selected?

Operating Cash Flow

The financial staff of Cairn Communications has identified the following information for the first year of the roll-out of its new proposed service:

Projected sales $25 million

Operating costs (not including depreciation) $10 million

Depreciation $6 million

Interest expense $4 million

The company faces a 35% tax rate. What is the project's operating cash flow for the first year (t = 1)?

Net Salvage Value

Allen Air Lines must liquidate some equipment that is being replaced. The equipment originally cost $13 million, of which 80% has been depreciated. The used equipment can be sold today for $3.25 million, and its tax rate is 35%. What is the equipment's after-tax net salvage value?

New-Project Analysis

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $1,070,000, and it would cost another $18,000 to install it. The machine falls into the MACRS 3-year class (the applicable MACRS depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%), and it would be sold after 3 years for $585,000. The machine would require an increase in net working capital (inventory) of $8,500. The sprayer would not change revenues, but it is expected to save the firm $368,000 per year in before-tax operating costs, mainly labor. Campbell's marginal tax rate is 30%.

a.What is the Year 0 net cash flow?

$

b.What are the net operating cash flows in Years 1, 2, and 3?

Year 1

$

Year 2

$

Year 3

$

c.What is the additional Year 3 cash flow (i.e, the after-tax salvage and the return of working capital)?

$

d.If the project's cost of capital is 11 %, what is the NPV of the project?

$

Should the machine be purchased?

AFN equation

Broussard Skateboard's sales are expected to increase by 20% from $8.8 million in 2016 to $10.56 million in 2017. Its assets totaled $3 million at the end of 2016. Broussard is already at full capacity, so its assets must grow at the same rate as projected sales. At the end of 2016, current liabilities were $1.4 million, consisting of $450,000 of accounts payable, $500,000 of notes payable, and $450,000 of accruals. The after-tax profit margin is forecasted to be 3%, and the forecasted payout ratio is 65%. Use the AFN equation to forecast Broussard's additional funds needed for the coming year.

$

AFN equation

Broussard Skateboard's sales are expected to increase by 25% from $8.4 million in 2016 to $10.50 million in 2017. Its assets totaled $6 million at the end of 2016. Broussard is already at full capacity, so its assets must grow at the same rate as projected sales. At the end of 2016, current liabilities were $1.4 million, consisting of $450,000 of accounts payable, $500,000 of notes payable, and $450,000 of accruals. The after-tax profit margin is forecasted to be 7%, and the forecasted payout ratio is 55%. What would be the additional funds needed?

$

AFN Equation

Broussard Skateboard's sales are expected to increase by 20% from $7.0 million in 2016 to $8.40 million in 2017. Its assets totaled $5 million at the end of 2016. Broussard is already at full capacity, so its assets must grow at the same rate as projected sales. At the end of 2016, current liabilities were $1.4 million, consisting of $450,000 of accounts payable, $500,000 of notes payable, and $450,000 of accruals. The after-tax profit margin is forecasted to be 5%. Assume that the company pays no dividends. Under these assumptions, what would be the additional funds needed for the coming year?

$

Why is this AFN different from the one when the company pays dividends?

Under this scenario the company would have a lower level of retained earnings but this would have no effect on the amount of additional funds needed.

Under this scenario the company would have a higher level of retained earnings which would reduce the amount of additional funds needed.

Under this scenario the company would have a higher level of retained earnings which would increase the amount of additional funds needed.

Under this scenario the company would have a higher level of retained earnings but this would have no effect on the amount of additional funds needed.

Under this scenario the company would have a lower level of retained earnings which would reduce the amount of additional funds needed.

Forecasted Statements and Ratios

Upton Computers makes bulk purchases of small computers, stocks them in conveniently located warehouses, ships them to its chain of retail stores, and has a staff to advise customers and help them set up their new computers.

Upton's balance sheet as of December 31, 2016, is shown here (millions of dollars):

Cash$3.5

Accounts payable$9.0

Receivables26.0

Notes payable18.0

Inventories58.0

Line of credit0

Total current assets$87.5

Accruals8.5

Net fixed assets35.0

Total current liabilities$35.5

Mortgage loan6.0

Common stock15.0

Retained earnings66.0

Total assets$122.5

Total liabilities and equity$122.5

Sales for 2016 were $225 million and net income for the year was $6.75 million, so the firm's profit margin was 3.0%. Upton paid dividends of $2.7 million to common stockholders, so its payout ratio was 40%. Its tax rate was 40%, and it operated at full capacity. Assume that all assets/sales ratios, (spontaneous liabilities)/sales ratios, the profit margin, and the payout ratio remain constant in 2017.

If sales are projected to increase by $40 million, or 17.78%, during 2017, use the AFN equation to determine Upton's projected external capital requirements. Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000.

1. $million
3. Using the AFN equation, determine Upton's self-supporting growth rate. That is, what is the maximum growth rate the firm can achieve without having to employ non spontaneous external funds?
4. %
5. Use the forecasted financial statement method to forecast Upton's balance sheet for December 31, 2017. Assume that all additional external capital is raised as a line of credit at the end of the year and is reflected (because the debt is added at the end of the year, there will be no additional interest expense due to the new debt).
6. Assume Upton's profit margin and dividend payout ratio will be the same in 2017 as they were in 2016. What is the amount of the line of credit reported on the 2017 forecasted balance sheets? (Hint:You don't need to forecast the income statements because the line of credit is taken out on last day of the year and you are given the projected sales, profit margin, and dividend payout ratio; these figures allow you to calculate the 2017 addition to retained earnings for the balance sheet without actually constructing a full income statement.)
7. Upton Computers
8. Pro Forma Balance Sheet
9. December 31, 2017
10. (Millions of Dollars)
11. Cash$
12. Receivables$
13. Inventories$
14. Total current assets$
15. Net fixed assets$
16. Total assets$
17. Accounts payable$
18. Notes payable$
19. Line of credit$Accruals$
20. Total current liabilities$
21. Mortgage loan$
22. Common stock$
23. Retained earnings$
24. Total liabilities and equity$

Financing Deficit

Garlington Technologies Inc.'s 2016 financial statements are shown below:

Balance Sheet as of December 31, 2016

Cash$180,000

Accounts payable$360,000

Receivables360,000

Notes payable156,000

Inventories720,000

Line of credit0

Total current assets$1,260,000

Accruals180,000

Fixed assets1,440,000

Total current liabilities$696,000

Common stock1,800,000

Retained earnings204,000

Total assets$2,700,000

Total liabilities and equity$2,700,000

Income Statement for December 31, 2016

Sales$3,600,000

Operating costs3,279,720

EBIT$320,280

Interest18,280

Pre-tax earnings$302,000

Taxes (40%)120,800

Net income181,200

Dividends$108,000

Suppose that in 2017 sales increase by 5% over 2016 sales and that 2017 dividends will increase to $188,000. Forecast the financial statements using the forecasted financial statement method. Assume the firm operated at full capacity in 2016. Use an interest rate of 10%, and assume that any new debt will be added at the end of the year (so forecast the interest expense based on the debt balance at the beginning of the year).

Garlington Technologies Inc.

Pro Forma Income Statement

December 31, 2017

Sales$

Operating costs$

EBIT$

Interest$

Pre-tax earnings$

Taxes (40%)$

Net income$

Dividends:$

Addition to RE:$

Garlington Technologies Inc.

Pro Forma Balance Statement

December 31, 2017

Cash$

Receivables$

Inventories$

Total current assets$

Fixed assets$

Total assets$

Accounts payable$

Notes payable$Accruals$

Total current liabilities$

Common stock$

Retained earnings$

Total liabilities and equity$