Problem Set on the Cash Flow Estimation

1. Truman Industries is considering an expansion project. The necessary equipment could be purchased for $9 million, and the project would also require an initial $3 million investment in net working capital. The Company? tax rate is 40 percent. What is the project?s initial investment outlay?

2. Eisenhower Communications is trying to estimate the first-year operating cash flows (at ) for a proposed project. The financial staff has collected the following information:

Projected sales $10 million

Operating costs (excluding depreciation) $ 7 million

Depreciation $ 2 million

Interest expense $ 2 million

The company faces a 40 percent tax rate. What is the project?s operating cash flow for the first year ()?

3. Kennedy Air Lines is now in the terminal year of a project. The equipment originally cost $20 million, of which 80 percent has been depreciated. Kennedy can sell the used equipment today to another airline for $5 million, and its tax rate is 40 percent. What is the equipment?s net salvage value?

4. You have been asked by the president of your company to evaluate the proposed acquisition of a spectrometer for the firm?s R&D department. The equipment?s base price is $140,000, and it would cost another $30,000 to modify it for special use by your firm. The spectrometer, which falls into the MACRS 3-year class, would be sold at the end of the third year for $60,000. The applicable annual depreciation rates are 33%, 45%, 15%, and 7%. Use of the equipment would require an increase in net working capital (spare parts inventory) of $8,000. The spectrometer would have no effect on revenues, but it is expected to save the firm $50,000 per year in before-tax operating costs, mainly labor. The firm?s marginal federal-plus-state tax rate is 40 percent.

a. What is the initial investment outlay of the spectrometer? (That is, what is the Year 0 net cash flow?)

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

c. What is the terminal cash flow?

d. If the project?s cost of capital is 12 percent, should the spectrometer be purchased according to the NPV rule of capital budgeting?

Problem Set on the Cash Flow Estimation 1. Truman Industries is considering an expansion project. The necessary equipment could be purchased for $9 million, and the project would also require an initial $3 million investment in net working capital. The Company' tax rate is 40 percent. What is the project's initial investment outlay? 2. Eisenhower Communications is trying to estimate the first-year operating cash flows (at t=1) for a proposed project. The financial staff has collected the following information: Projected sales Operating costs (excluding depreciation) Depreciation Interest expense $10 million $ 7 million $ 2 million $ 2 million The company faces a 40 percent tax rate. What is the project's operating cash flow for the first year (t=1)? 3. Kennedy Air Lines is now in the terminal year of a project. The equipment originally cost $20 million, of which 80 percent has been depreciated. Kennedy can sell the used equipment today to another airline for $5 million, and its tax rate is 40 percent. What is the equipment's net salvage value? 4. You have been asked by the president of your company to evaluate the proposed acquisition of a spectrometer for the firm's R&D department. The equipment's base price is $140,000, and it would cost another $30,000 to modify it for special use by your firm. The spectrometer, which falls into the MACRS 3-year class, would be sold at the end of the third year for $60,000. The applicable annual depreciation rates are 33%, 45%, 15%, and 7%. Use of the equipment would require an increase in net working capital (spare parts inventory) of $8,000. The spectrometer would have no effect on revenues, but it is expected to save the firm $50,000 per year in before-tax operating costs, mainly labor. The firm's marginal federal-plus-state tax rate is 40 percent. a. What is the initial investment outlay of the spectrometer? (That is, what is the Year 0 net cash flow?) b. What are the operating cash flows in Years 1, 2, and 3? c. What is the terminal cash flow? d. If the project's cost of capital is 12 percent, should the spectrometer be purchased according to the NPV rule of capital budgeting