311.

313.8

8. You are considering the following project:

  • The project will last for 4 years. Each year you will have revenues of $230,000 and expenses of $100,000. The project will require new equipment valued at $80,000. This equipment will be depreciated to 0 using the straight-line method over a four-year life. Your tax rate is 33%. Working capital at the firm will have to rise to $20,000 from the current level of $10,000 immediately. It will go down to $15,000 in year 2 and to $10,000 in year 4. You will transfer one manager already working for you to the project and hire a new one at the same salary--$30,000 per year. You will also sell the equipment for $10,000 in year 4. Forecast all of the incremental cash flows for this project and compute its present value based on a discount rate of 10%. (22)

    • This is similar to the CB questions we did in class (like the JoePa one) and to the 2 Makeup 6, question 1. This is a 4 year project, but the cash flows are largely the same every year, so you only have to figure out what they are in the typical year.

    Revenues 230000
    Expenses 100000
    Salary (2 mgrs) 60000
    Depreciation 20000 (= 80000/4 for straight-line)
    EBIT 50000
    Taxes (.33) 16500
    Net Income 33500
    Add-back Depr 20000
    OpCF 53500

    So, each year, you will have OpCF of 53500. Additionally, you will have startup cash flows of -80000 for the purchase of the equipment and –10000 due to your additional investment of $10000 in working capital immediately. In year 2, you will get some of that back in the form of a positive cashflow of 5000 as w.c. comes down and you will get the other 5000 back in year 4. Finally, you will have a terminal cashflow when you sell the equipment in year 4. You will sell it for $10,000, which is 10,000 more than its book value of 0, so you will be taxed on the sale, leaving you with $10000 (1-.33) =$6700. So, your 6 free cash flows look like:

    0 1 2 3 4
    -90000 53500 53500+5000 53500 53500+5000+6700

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