Kinky copies may buy a high volume copier

1. Quick Computing currently sells 16 million computer chips each year at a price of $30 per chip. It is about to introduce a new chip, and it forecasts annual sales of 18 million of these improved chips at a price of $38 each. However, demand for the old chip will decrease, and sales of the old chip are expected to fall to 2 million per year. The old chip costs $15 each to manufacture, and the new ones will cost $18 each. What is the proper cash flow to use to evaluate the present value of the introduction of the new chip? (Enter your answer in millions.)

Cash flow

$

million

2.

Tubby Toys estimates that its new line of rubber ducks will generate sales of $7.80 million, operating costs of $4.80 million, and a depreciation expense of $1.80 million. Assume the tax rate is 30%.

a.

Calculate the operating cash flow for the year by using all three methods: (a) adjusted accounting profits; (b) cash inflow/cash outflow analysis; and (c) the depreciation tax shield approach. (Enter your answers in millions rounded to 2 decimal places.)

Method

Cash Flow

Adjusted accounting profits

$ million

Cash inflow/cash outflow analysis

million

Depreciation tax shield approach

million

b.

Are the above answers equal?

Yes

No

3.

The owner of a bicycle repair shop forecasts revenues of $164,000 a year. Variable costs will be $51,000, and rental costs for the shop are $31,000 a year. Depreciation on the repair tools will be $11,000. Prepare an income statement for the shop based on these estimates. The tax rate is 40%. (Input all amounts as positive values.)

INCOME STATEMENT

$

Rental costs

$

4.

Laurel’s Lawn Care, Ltd., has a new mower line that can generate revenues of $168,000 per year. Direct production costs are $56,000, and the fixed costs of maintaining the lawn mower factory are $23,000 a year. The factory originally cost $1.4 million and is being depreciated for tax purposes over 25 years using straight-line depreciation. Calculate the operating cash flows of the project if the firm’s tax bracket is 40%. (Enter your answer in dollars not in millions.)

Operating cash flows

$

5.

Gluon Inc. is considering the purchase of a new high pressure glueball. It can purchase the glueball for $180,000 and sell its old low-pressure glueball, which is fully depreciated, for $32,000. The new equipment has a 10-year useful life and will save $40,000 a year in expenses. The opportunity cost of capital is 8%, and the firm’s tax rate is 40%. What is the equivalent annual savings from the purchase if Gluon uses straight-line depreciation? Assume the new machine will have no salvage value. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Equivalent annual savings

$

6.

Johnny’s Lunches is considering purchasing a new, energy-efficient grill. The grill will cost $45,000 and will be depreciated according to the 3-year MACRS schedule. It will be sold for scrap metal after 3 years for $11,250. The grill will have no effect on revenues but will save Johnny’s $22,500 in energy expenses per year. The tax rate is 30%. Use the MACRS depreciation schedule .

a.

What are the operating cash flows in each year? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Year

Operating Cash Flows

1

$

2

3

b.

What are the total cash flows in each year? (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to 2 decimal places.)

Time

Total Cash Flows

0

$

1

2

3

c.

If the discount rate is 10%, should the grill be purchased?

Yes

No

7.

Revenues generated by a new fad product are forecast as follows:

Year

Revenues

1

$44,000

2

30,000

3

20,000

4

10,000

Thereafter

0

Expenses are expected to be 50% of revenues, and working capital required in each year is expected to be 20% of revenues in the following year. The product requires an immediate investment of $48,000 in plant and equipment.

a.

What is the initial investment in the product? Remember working capital.

Initial investment

$

b.

If the plant and equipment are depreciated over 4 years to a salvage value of zero using straight-line depreciation, and the firm’s tax rate is 40%, what are the project cash flows in each year? Assume the plant and equipment are worthless at the end of 4 years. (Do not round intermediate calculations.)

Year

Cash Flow

1

$

2

3

4

c.

If the opportunity cost of capital is 15%, what is the project's NPV? (A negative value should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)

NPV

$

d.

What is project IRR? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

IRR

%

8.

Kinky Copies may buy a high-volume copier. The machine costs $60,000 and will be depreciated straight-line over 5 years to a salvage value of $10,000. Kinky anticipates that the machine actually can be sold in 5 years for $22,000. The machine will save $10,000 a year in labor costs but will require an increase in working capital, mainly paper supplies, of $5,000. The firm’s marginal tax rate is 35%, and the discount rate is 11%. (Assume the net working capital will be recovered at the end of Year 5.)

Calculate the NPV. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)

NPV

$

Should Kinky buy the machine?

Yes

No

9.

Quick Computing installed its previous generation of computer chip manufacturing equipment 3 years ago. Some of that older equipment will become unnecessary when the company goes into production of its new product. The obsolete equipment, which originally cost $38 million, has been depreciated straight-line over an assumed tax life of 5 years, but it can be sold now for $17.6 million. The firm’s tax rate is 30%. What is the after-tax cash flow from the sale of the equipment? (Enter your answer in millions rounded to 2 decimal places.)

After-tax cash flow

$ million

10.

Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $4,800 and sell its old washer for $1,200. The new washer will last for 6 years and save $1,400 a year in expenses. The opportunity cost of capital is 18%, and the firm’s tax rate is 40%.

a.

If the firm uses straight-line depreciation to an assumed salvage value of zero over a 6-year life, what is the annual operating cash flow of the project in years 1 to 6? The new washer will in fact have zero salvage value after 6 years, and the old washer is fully depreciated.

Annual operating cash flow

$

b.

What is project NPV? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)

NPV

$

c.

What is NPV if the firm uses MACRS depreciation with a 5-year tax life? Use the MACRS depreciation schedule . (Do not round intermediate calculations. Round your answer to 2 decimal places.)

NPV

$

11

Canyon Tours showed the following components of working capital last year:

Beginning

End of Year

Accounts receivable

$24,800

$23,400

Inventory

12,400

13,300

Accounts payable

14,900

17,300

a.

What was the change in net working capital during the year? (A negative amount should be indicated by a minus sign.)

Change in net working capital

$

b.

If sales were $36,400 and costs were $24,400, what was cash flow for the year? Ignore taxes.

Cash flow

$

12.

A house painting business had revenues of $16,200 and expenses of $9,200 last summer. There were no depreciation expenses. However, the business reported the following changes in working capital:

Beginning

End

Accounts receivable

$1,400

$4,700

Accounts payable

740

320

Calculate net cash flow for the business for this period.

Net cash flow

$

13

Better Mousetraps has developed a new trap. It can go into production for an initial investment in equipment of $5.7 million. The equipment will be depreciated straight line over 6 years to a value of zero, but in fact it can be sold after 6 years for $518,000. The firm believes that working capital at each date must be maintained at a level of 10% of next year’s forecast sales. The firm estimates production costs equal to $1.50 per trap and believes that the traps can be sold for $6 each. Sales forecasts are given in the following table. The project will come to an end in 6 years., when the trap becomes technologically obsolete. The firm’s tax bracket is 35%, and the required rate of return on the project is 9%. Use the MACRS depreciation schedule .

Year:

0

1

2

3

4

5

6

Thereafter

Sales (millions of traps)

0

.4

.5

.6

.6

.4

.2

0

a.

What is project NPV? (Do not round intermediate calculations. Enter your answer in millions rounded to 4 decimal places.)

NPV

$ million

b.

By how much would NPV increase if the firm depreciated its investment using the 5-year MACRS schedule? (Do not round intermediate calculations. Enter your answer in whole dollars not in millions.)

The NPV increases by $ .

14.

The efficiency gains resulting from a just-in-time inventory management system will allow a firm to reduce its level of inventories permanently by $581,000. What is the most the firm should be willing to pay for installing the system?

Firm should willing to pay

$

15.

Better Mousetraps has developed a new trap. It can go into production for an initial investment in equipment of $6.3 million. The equipment will be depreciated straight line over 6 years to a value of zero, but in fact it can be sold after 6 years for $538,000. The firm believes that working capital at each date must be maintained at a level of 15% of next year’s forecast sales. The firm estimates production costs equal to $1.00 per trap and believes that the traps can be sold for $4 each. Sales forecasts are given in the following table. The project will come to an end in 6 years., when the trap becomes technologically obsolete. The firm’s tax bracket is 35%, and the required rate of return on the project is 9%. Use the MACRS depreciation schedule .

Year:

0

1

2

3

4

5

6

Thereafter

Sales (millions of traps)

0

.4

.5

.7

.7

.5

.4

0

Suppose the firm can cut its requirements for working capital in half by using better inventory control systems. By how much will this increase project NPV? (Enter your answer in millions rounded to 4 decimal places.)