Scenario 2. Based on the given information, please answer the following questions in detail.
200,000 5% 1) Life Period of the Equipment = 4 years 5 2) New equipment cost 6 3) Equipment ship & Install cost 7 4) Related start up cost 8 5) Inventory Increase 96) Accounts Payable Increase 107) Equip. salvage value before tax 8) Sales for first year (1) (200,000) 9) Sales increase per year (35,000) 10) Operating cost (60% of Sales) (5,000) (as a percent of sales In Year 1) 25,000 11) Depreciation (Full depreciation) 5,000 12) Marginal Corporate Tax Rate (T) 15,000 13) Cost of Capital (Discount Rate) (120,000) -60% (240,000) 21% 10% 12 B Year 5 Operations: I/S 16 Revenue z Operating Cost 18 Depreciation 19 EBIT 20 Taxes 21 Net Income $ 200,000 $ 210,000 $ 220,500 $ 231,525 $ (120,000) $ (126,000) $ (132,300) $ (138,915) $ (240,000) $ $ (160,000) $ 84,000 $ 88,200 $ 92,610 (33,600) $ 17,640 $ 18,522 $ 19,448.10 $ (126,400) $ 66,360 $ 69,678 $ 73,162 23 Add back Depreciation $ 240,000 $ 25 Total Operating Cash Flow $ 113,600 $ 66,360 $ 69,678 $ 73,162 26 e7 ESTIMATING Initial Outlay (Cash Flow, CFO, T=0) CFO CF1 CF2 CF3 CF4 30 Year Investments: 32 1) Equipment cost 33 2) Shipping and Install cost 34 3) Start up expenses 55 Total Basis Cost (1+2+3) 36 4) Net Working Capital 37 Increase in CA - Increase in CL Total Initial Outlay A LA LA LA $ (200,000) $ (35,000) (5,000) $ (240,000) $ (20,000) $ (260,000) 58 Terminal: 1) Change in net WC 2) Salvage value (after tax) Total - Salvage Value Before Tax (1-T) $ $ $ 20,000 11.850 31,850 Project Net Cash Flows $ (260,000) $ 113,600 $ 66,360 $ 69,678 $ 105,012 NPV = $22,190 IRR = 14.0% Payback 3.1 years 50 QH Impact of 2017 Tax Cut Act on Net Income, Cash Flows and Capital Budgeting (Investment) Decisions Estimate NPV, IRR and Payback period of the project if equipment is fully depreciated in the first year and tax rate equals to 21%. 52 (a) 54 (6) Would you accept the project based on NPV and IRR? 56 (C) Would you accept the project based on Payback rule if the project cut-off is 3 years? 59 QW2 As a CFO of the firm, which of the Scenarios (1) or (2) would you choose? Why? 200,000 5% 1) Life Period of the Equipment = 4 years 5 2) New equipment cost 6 3) Equipment ship & Install cost 7 4) Related start up cost 8 5) Inventory Increase 96) Accounts Payable Increase 107) Equip. salvage value before tax 8) Sales for first year (1) (200,000) 9) Sales increase per year (35,000) 10) Operating cost (60% of Sales) (5,000) (as a percent of sales In Year 1) 25,000 11) Depreciation (Full depreciation) 5,000 12) Marginal Corporate Tax Rate (T) 15,000 13) Cost of Capital (Discount Rate) (120,000) -60% (240,000) 21% 10% 12 B Year 5 Operations: I/S 16 Revenue z Operating Cost 18 Depreciation 19 EBIT 20 Taxes 21 Net Income $ 200,000 $ 210,000 $ 220,500 $ 231,525 $ (120,000) $ (126,000) $ (132,300) $ (138,915) $ (240,000) $ $ (160,000) $ 84,000 $ 88,200 $ 92,610 (33,600) $ 17,640 $ 18,522 $ 19,448.10 $ (126,400) $ 66,360 $ 69,678 $ 73,162 23 Add back Depreciation $ 240,000 $ 25 Total Operating Cash Flow $ 113,600 $ 66,360 $ 69,678 $ 73,162 26 e7 ESTIMATING Initial Outlay (Cash Flow, CFO, T=0) CFO CF1 CF2 CF3 CF4 30 Year Investments: 32 1) Equipment cost 33 2) Shipping and Install cost 34 3) Start up expenses 55 Total Basis Cost (1+2+3) 36 4) Net Working Capital 37 Increase in CA - Increase in CL Total Initial Outlay A LA LA LA $ (200,000) $ (35,000) (5,000) $ (240,000) $ (20,000) $ (260,000) 58 Terminal: 1) Change in net WC 2) Salvage value (after tax) Total - Salvage Value Before Tax (1-T) $ $ $ 20,000 11.850 31,850 Project Net Cash Flows $ (260,000) $ 113,600 $ 66,360 $ 69,678 $ 105,012 NPV = $22,190 IRR = 14.0% Payback 3.1 years 50 QH Impact of 2017 Tax Cut Act on Net Income, Cash Flows and Capital Budgeting (Investment) Decisions Estimate NPV, IRR and Payback period of the project if equipment is fully depreciated in the first year and tax rate equals to 21%. 52 (a) 54 (6) Would you accept the project based on NPV and IRR? 56 (C) Would you accept the project based on Payback rule if the project cut-off is 3 years? 59 QW2 As a CFO of the firm, which of the Scenarios (1) or (2) would you choose? Why
