Colsen Communications is trying to estimate the first-year cash flow (at Year 1) for a proposed project. The financial staff has collected the following information on the project:

$$\begin{matrix} \text{Sales revenues} & \text{\$ 15 million}\\ \text{Operating costs (exluding depreciation)} & \text{10.5 million}\\ \text{Depreciation} & \text{3 million}\\ \text{Interest expense} & \text{3 million}\\ \end{matrix}$$

The company has a 40% tax rate, and its WACC is 11%. a. What is the project’s cash flow for the first year (t=1)? b. If this project would cannibalize other projects by $1.5 million of cash flow before taxes per year, how would this change your answer to part a? c. Ignore part b. If the tax rate dropped to 30%, how would that change your answer to part a?

Eisenhower Communications is trying to estimate the first-year cash flow (at Year $1$) for a proposed project. The financial staff has collected the following information on the project:

$$\begin{array}{lc} \text{Sales revenues} & \$ 10 \text{ million} \\ \text{Operating costs (excluding depreciation)} & 7 \text{ million} \\ \text{Depreciation} & 2 \text{ million} \\ \text{Interest expense} & 2 \text{ million} \end{array}$$

The company has a $40 \%$ tax rate, and its WACC is $10 \%$.

a. What is the project's cash flow for the first year $(t=1)$ ?

b. If this project would cannibalize other projects by $\$ 1$ million of cash flow before taxes per year, how would this change your answer to previous part?

c. Ignore part b. If the tax rate dropped to $30 \%$, how would that change your answer to part a?

The Dauten Toy Corporation currently uses an injection molding machine that was purchased 2 years ago. This machine is being depreciated on a straight-line basis, and it has 6 years of remaining life. Its current book value is $2,100, and it can be sold for$2,500 at this time. Thus, the annual depreciation expense is $2,100 6=$350 per year. If the old machine is not replaced, it can be sold for $500 at the end of its useful life. Dauten is offered a replacement machine which has a cost of$8,000, an estimated useful life of 6 years, and an estimated salvage value of $800. This machine falls into the MACRS 5-year class so the applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. The replacement machine would permit an output expansion, so sales would rise by$1,000 per year; even so, the new machine’s much greater efficiency would cause operating expenses to decline by $1,500 per year. The new machine would require that inventories be increased by$2,000, but accounts payable would simultaneously increase by $500. Dauten’s marginal federal-plus-state tax rate is 40%, and its WACC is 11%. Should it replace the old machine?

You must evaluate a proposal to buy a new milling machine. The base price is 135,000 dollars and shipping and installation costs would add another 8,000 dollars. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for 94,500 dollars. The applicable depreciation rates are 33 percent, 45 percent, 15 percent, and 7 percent. The machine would require a 5,000 dollars increase in net operating working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline by 52,000 dollars per year. The marginal tax rate is 35 percent, and the WACC is 8 percent. Also, the firm spent 4,500 dollars last year investigating the feasibility of using the machine.

a. How should the 4,500 dollars spent last year be handled?

b. What is the initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year 0 project cash flow?

c. What are the project’s annual cash flows during Years 1, 2, and 3?

d. Should the machine be purchased? Explain your answer.

The Oviedo Company is considering the purchase of a new machine to replace an obsolete one. The machine being used for the operation has a book value and a market value of zero. However, the machine is in good working order and will last at least another 10 years. The proposed replacement machine will perform the operation so much more efficiently that Oviedo’s engineers estimate that it will produce after-tax cash flows (labor savings and depreciation) of $8,000 per year. The new machine will cost$45,000 delivered and installed, and its economic life is estimated to be 10 years. It has zero salvage value. The firm’s WACC is 10%, and its marginal tax rate is 35%. Should Oviedo buy the new machine?

Tannen Industries is considering an expansion. The necessary equipment would be purchased for 18 million dollars, and the expansion would require an additional 2 million dollars investment in net operating working capital. The tax rate is 40 percent.

a. What is the initial investment outlay?

b. The company spent and expensed 20,000 dollars on research related to the project last year. Would this change your answer? Explain.

c. The company plans to use a building that it owns to house the project. The building could be sold for 1 million dollars after taxes and real estate commissions. How would that fact affect your answer?

Kennedy Air Services is now in the final year of a project. The equipment originally cost $\$ 20$ million, of which $80 \%$ has been depreciated. Kennedy can sell the used equipment today for $\$ 5$ million, and its tax rate is $40 \%$. What is the equipment's after-tax salvage value?

Define (a) sensitivity analysis, (b) scenario analysis, and (c) simulation analysis. If GE were considering two projects (one for $500 million to develop a satellite communications system and the other for$30,000 for a new truck), on which would the company be more likely to use a simulation analysis?

Allied Food Products is considering expanding into the fruit juice business with a new fresh lemon juice product. Assume that you were recently hired as assistant to the director of capital budgeting, and you must evaluate the new project.

The lemon juice would be produced in an unused building adjacent to Allied's Fort Myers plant; Allied owns the building, which is fully depreciated. The required equipment would cost $\$ 200,000$, plus an additional $\$ 40,000$ for shipping and installation. In addition, inventories would rise by $\$ 25,000$, while accounts payable would increase by $\$ 5,000$. All of these costs would be incurred at $t=0$. By a special ruling, the machinery could be depreciated under the MACRS system as $3$-year property. The applicable depreciation rates are $33 \%, 45 \%, 15 \%$, and $7 \%$.

The project is expected to operate for $4$ years, at which time it will be terminated. The cash inflows are assumed to begin $1$ year after the project is undertaken, or at $t=1$, and to continue out to $t=4$. At the end of the project's life $(t=4)$, the equipment is expected to have a salvage value of $\$ 25,000$.

Unit sales are expected to total $100,000$ units per year, and the expected sales price is $\$ 2.00$ per unit. Cash operating costs for the project (total operating costs less depreciation) are expected to total $60 \%$ of dollar sales. Allied's tax rate is $40 \%$, and its WACC is $10 \%$. Tentatively, the lemon juice project is assumed to be of equal risk to Allied's other assets.

You have been asked to evaluate the project and to make a recommendation as to whether it should be accepted or rejected. To guide you in your analysis, your boss gave you the following set of tasks/ questions:

If this project had been a replacement rather than an expansion project, how would the analysis have changed? Think about the changes that would have to occur in the cash flow table.

Representative Sam Johnson: "Working to Reduce Your Tax Burden" I believe that our current tax code is economically destructive, impossibly complex, and overly intrusive. It has impeded our ability to create jobs, encourage savings and investment, and realize the American dream. This is illustrated by the fact that our current tax code has grown from 11,000 words to over 7 million. According to West Publishing, who is an official publisher of the tax code, it takes two volumes and 1,168 pages to publish the code, plus, an additional 6,439 pages of Federal Tax Regulations that apply to income taxes. To make it easier to comply with these regulations, the IRS has created about 480 forms with an additional 280 to explain how to fill out the 480. I think this is ridiculous. That is why this system should not be changed, but replaced... What is Representative Johnson's point of view on tax policy?

Charlene is evaluating a capital budgeting project that should last for 4 years. The project requires 800,000 dollars of equipment. She is unsure what depreciation method to use in her analysis, straight-line or the 3-year MACRS accelerated method. Under straight-line depreciation, the cost of the equipment would be depreciated evenly over its 4-year life (ignore the half-year convention for the straight-line method). The applicable MACRS depreciation rates are 33 percent, 45 percent, 15 percent, and 7 percent. The company's WACC is 8 percent, and its tax rate is 35 percent.

a. What would the depreciation expense be each year under each method?

b. Which depreciation method would produce the higher NPV, and how much higher would it be?

In theory, market risk should be the only “relevant” risk. However, companies focus as much on stand-alone risk as on market risk. What are the reasons for the focus on standalone risk?

Project L costs $65,000, its expected cash inflows are$12,000 per year for 9 years, and its WACC is 9%. What is the project’s NPV?

A firm with a 14% WACC is evaluating two projects for this year’s capital budget. After-tax cash flows, including depreciation, are as follows:

$$\begin{matrix} \text{ } & \text{0} & \text{1} & \text{2} & \text{3} & \text{4} & \text{5}\\ \text{Project A} & \text{-\$ 30.000} & \text{\$ 10.000} & \text{\$ 10.000} & \text{\$ 10.000} & \text{\$ 10.000} & \text{\$ 10.000}\\ \text{Project B} & \text{-\$ 90.000} & \text{\$ 28.000} & \text{\$ 28.000} & \text{\$ 28.000} & \text{\$ 28.000} & \text{\$ 28.000}\\ \end{matrix}$$

a. Calculate NPV, IRR, MIRR, payback, and discounted payback for each project. b. Assuming the projects are independent, which one(s) would you recommend? c. If the projects are mutually exclusive, which would you recommend? d. Notice that the projects have the same cash flow timing pattern. Why is there a conflict between NPV and IRR?