Optimal Product Mix

A business is considering production of a new product. This production would require an initial

capital outlay of $90 million. This capital expenditure can be depreciated (straight line) over a 3-year

life of the project with no salvage value. Assume the firm faces a 33% marginal tax rate and a cost of

capital of 8%. If the project is funded, the resulting Net Operating Profit BEFORE Depreciation &

Taxes (think EBITDA) are given below.

For purposes of your initial analysis (parts a through d) assume that accounting depreciation and

economic depreciation are the same.

Net Operating Profit BEFORE Depreciation & Taxes (EBITDA)

Year 1$35,000,000

Year 2 $40,000,000

Year 3$45,000,000

(a) Calculate the Cash Flow and Economic Profit for each year. Reminder, the "year

0"is included to capture the initial outflow in the CF analysis. Show your work.

Cash FlowEconomic Profit

Year 0

Year 1

Year 2

Year 3

(b) What is present value of the cash flows for this project? Show your work.

PV of CF =___________________________________________

(c) What is the present value of the stream of economic profits Show your work.

PV of EP = _______________________________________-

(d) If the tax code were changed to allow managers to "expense" their capital

expenditure (in this context, "expense" means take the full tax deduction from a

capital expenditure immediately rather than depreciate it), would the present

value of cash flows rise or fall? WHY?

PV of the Cash Flows would RISE or FALL (Circle one)