Wendy's boss wants to use straight-line depreciation

(11-2)

Operating Cash FIow

(x1-3)

Net Salvage Value

(11-4)

Replacement Analysis

Intermediate Problems 5-11

(11-s)

Depreciation Methods

F1-6) New-Project Analysis

Part 4 Projects and Their Valuation

The financial staff of Cairn Communications has identified the following information for the first year of the roll-out ofits new proposed seryice:

Projected sales $18 million Operating costs (not including depreciation) $ 9 million Depreciation

Interest expense

$ 4 mition $ 3 million

The company faces a 40o/o tax rate. What is the project's operating cash flow for the fust year (t = 1)?

Allen Ak Lines must liquidate some equipment that is being replaced. The equipment originally cost $12 million, of which 75o/ohas been depreciated. The used equipment can be sold today for $4 rnillion, and its tax rate is 40Yo. What is the equipment's after-tax net salvage value?

Although the Chen Company's milling machine is old, it is still in relatively good working order and would last for another l0 years. It is inefficient compared to modem standards, though, and so the company is considering replacing it. The new milling machine, at a cost of $110,000 delivered and instalied, would also last for 10 years and would produce after-tax cash flows (labor savings and depreciation tax savings) of $19,000 per year. It would have zero salvage value at the end of its life. The firm's WACC is 107o, and its marginal tax rate is 357o. Should Chen buy the new machine?

Wendy's boss wants to use straight-line depreciation for the new expansion project because he said it will give higher net income in earlier years and give him a larger bonus. The project will last 4 years and requires $1,700,000 of equipment. The company could use either straight line or the 3-year MACRS accelerated method. Under straight-line depreciation, the cost of the equipment would be depreciated evenly orrer its 4-year life (ignore the half-year convention for the straight-line method). The appiicable MACRS depreciation rates are 33.33%,44.45%, l4.8lo/o, and"7.4lo/o, as discussed in Appendix 11A. The company's WACC is 10%, and its tax rate is 40%.

a. What would &e depreciation expense be each year under each method? b. Which depreciation method would produce the higher NPV, and how much higher

would it be? c. Why might Wendy's boss prefer straight-line depreciation?

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $1,080,000, and it would cost another $22,500 to install it. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $605,000. The MACRS rates for the first three years are 0.3333, 0.4445, and 0.1481. The machine would require an increase in net working capital (inventory) of $15,500. The sprayer would not change revenues, but it is expected to save the firm $380,000 per year in before-tax operating costs, mainly labor. Campbell's marginal tax rate is 357o.

a. What is the Year 0 net cash flow? b. What are the net operating cash flows in Years 1, 2, and 3? c. What is the additional Year-3 cash flow (i.e., the after-tax salvage and the return of

working capital)? d. If the project's cost of capital is 127o, should the machine be purchased?

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