Question 5.

The Rubios Fantastic Cs is a medium-size, Los Angeles based company that has been in business for the last ten years. It specializes in manufacturing the air conditioners. Over the last two years, the Rubios has spent $20,000 developing a new energy efficient and eco-friendly air conditioner called EcoStar.

Suppose you are a financial consultant advising the Rubios on whether to build a new plant in San Diego that will manufacture the EcoStar. The current date is December 31, 2017. The plant will be built over the two years and will be ready to start production on January 1, 2020. The plant is expected to operate only for the two years and so it will cease production on December 31, 2021. The investment for the plant requires an outlay of $10 million to be paid at the end of 2017 year. The IRS rules prescribe that this expenditure is depreciated using the straight-line depreciation schedule (to 0$) over five years as soon as the plant starts producing. The plant is expected to be reselled for $5 million on December 31, 2021. The plant will be built on the land that could be rented out for $375,000 a year.

To launch the manufacture of the EcoStar, the firm would also need to acquire new equipment. The equipment will cost $1 million to be paid at the end of 2019 year and will be depreciated using the straight line depreciation over the two years the plant is manufacturing the EcoStar. After two-years of the manufacture the equipment has no salvage value.

The Fabios new plant will produce 100,000 air conditioners a year. The EcoStar air conditioner can be sold at $500 per unit. Raw materials costs are $220 per unit and total labor costs are $500,000 a year. These revenues and costs are expected to be the same for the two year the plant is producing.

The working capital required on December 31, 2019 to allow inventories to be financed during the first year of productions is $100,000. Working capital needs for the second year will be $200,000. When the plant ceases manufacture all the working capital will be recovered (i.e. working capital equals $0 on December 31, 2021).

The Rubios Fantastic Cs has a corporate tax rate of 20% and other profitable ongoing operations. The opportunity cost of capital for this kind of project is 10%.

For all questions state your solution in millions of dollars (i.e. instead of writing $1,000,000 write $1m).

Part (a) What are the depreciation tax shields associated with the purchase of new equipment?

Year Depreciation Schedule Depreciation Amount Depreciation Tax Shields

2017
2018
2019
2020
2021

Part (b)

What are the depreciation tax shields associated with the new plant?

Year Depreciation Proportion Depreciation Amount Depreciation Tax Shields

2017
2018
2019
2020
2021

Part(c)

What is the book value of the equipment and plant in every year?

Year	Book Value of Equipment	Book Value of Plant
2017
2018
2019
2020
2021

Part (d)

What is the capital gain tax (capital loss tax credit) that the firm incurs on December 31, 2021 when selling the plant?

Part (e)

What is the plants salvage value (net of taxes)?

Part (f)

What are the firms NOPAT in every year if the firm builds the plant and starts manufacturing the EcoStar? First, give the answers to the following questions and then fill in the table.

1. What are the firms revenues in the first year of production?
2. What are the firms costs in the first year of production (excluding depreciation)?
3. What is the firms EBIT (earnings before interest and tax) in the the first year of production?
4. What is the firms income taxes in the first year of production?
5. What is the firms NOPAT (net operating profit after tax) in the first year of production?

		2017	2018	2019	2020	2021
+ - - -	Revenues Raw Materials Costs Labor Costs Depreciation
= -	EBIT Tax
=	NOPAT

Part (g)

What is the level of NWC (net working capital) required for the EcoStar manufacture in every year?

2017 2018 2019 2020 2021

Net Working Capital

Part (h)

What are the free cash flows of the firm in every year that the firm manufactures the EcoStar?

2017	2018	2019	2020	2021