You have been retained as a consultant by a business that is considering production of a new product. This production would require an initial capital outlay of $100 million. This capital expenditure can be depreciated (straight line) over a 4-year life of the project with no salvage value. Assume the firm faces a 25% 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 $40,000,000 Year 2 $45,000,000 Year 3 $45,000,000 Year 4 $50,000,000

(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 Flow & Economic Profit

Year 0

Year 1

Year 2

Year 3

Year 4

(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 (assume that accounting depreciation and economic depreciation are the same). Show your work. PV of EP =

(d) How does the present value of the Economic Profits compare to the NPV of the cash flows for the project? Does that surprise you? Explain

(e) Now assume that the market value of the capital does not decrease as suggested by straight line accounting depreciation, but rather that the market value of the capital is given as listed below (in other words, accounting and economic depreciation are not the same).

At end of year 1 $60,000,000

At end of year 2 $35,000,000

At end of year 3 $15,000,000

At end of year 4 $0

Based on this economic depreciation schedule, calculate the economic profit of the project.

Economic Profit

Year 1

Year 2

Year 3

Year 4

(f) What is the present value of this stream of economic profit? Show your work. PV of EP =

(g) 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)