Question

We assume that the company you selected is considering a new project. The project has 8 years’ life. This project requires initial investment of $380 million to purchase equipment, and $30 million for shipping & installation fee. The fixed assets fall in the 7-year MACRS class. The salvage value of the fixed assets is 10.5% of the purchase price (including the shipping & installation fee). The number of units of the new product expected to be sold in the first year is 1,500,000 and the expected annual growth rate is 5.5%. The sales price is $255 per unit and the variable cost is $190 per unit in the first year, but they should be adjusted accordingly based on the estimated annualized inflation rate of 2.2%. The required net operating working capital (NOWC) is 9.5% of sales. Use the corporate tax rate obtained in Step (4) for the project. The project is assumed to have the same risk as the corporation, so you should use the WACC you obtained from prior steps as the discount rate. Note: you may revise the partial model in the file Ch11 P18 Build a Model.xls on the website of the textbook (also posted in this final project learning module in Blackboard) for capital budgeting analysis, but you are NOT required to strictly follow the partial model. Actually, you are encouraged to build a better model by yourself. - Compute the depreciation basis and annual depreciation of the new project. (You can refer to Table 11A-2 MACRS allowances on pp.496 in the textbook) - Estimate annual cash flows for 8 years. - Draw a time line of the cash flows. WACC = 7.20% Corporate Tax Rate = 18.30%

What is the salvage value of the fixed assets?

Answer 1

		Present Value of Cash Flow;
		(Cash Flow)/((1+i)^N)
		i=discount Rate=WACC=7.2%=0.072
		N=Year of cash Flow
		7 year MACRS
		Equipment Cost=	$380	million
		Shipping and installation	$30	million
		Total Depreciable asset	$410	million
			A	B=A*$410,000,000
			Depreciation	Amount of
		Year	Rate	Depreciation
		1	14.29%	$58,589,000
		2	24.49%	$100,409,000
		3	17.49%	$71,709,000
		4	12.49%	$51,209,000
		5	8.93%	$36,613,000
		6	8.92%	$36,572,000
		7	8.93%	$36,613,000
		8	4.46%	$18,286,000
		Salvage Value=10.5%*410 million	$43,050,000
		Taxes	18.3%
		After tax Salvage Value =43050000*(1-0.183)	$35,171,850
	N	Year	0	1	2	3	4	5	6	7	8
		Investments:
	a	Equipment Installed Cost	($410,000,000)
		Operations:
	.(1)	Sales in units(Sales growth 5.5%)		1,500,000	1,582,500	1,669,538	1,761,362	1,858,237	1,960,440	2,068,264	2,182,019
	.(2)	Price per unit(Annual price increase2.2%)		$255.00	$260.61	$266.34	$272.20	$278.19	$284.31	$290.57	$296.96
	.(1)*(2)	Sales Revenue		$382,500,000	$412,415,325	$444,670,328	$479,447,994	$516,945,621	$557,375,939	$600,968,311	$647,970,042
	.(3)	Unit Variable Cost(Annual increase 2.2%)		$190.00	$194.18	$198.45	$202.82	$207.28	$211.84	$216.50	$221.26
	.(1)*(3)	Variable Production Costs		-$285,000,000	-$307,289,850	-$331,322,989	-$357,235,760	-$385,175,169	-$415,299,719	-$447,780,310	-$482,801,208
		Depreciation Expense		-$58,589,000	-$100,409,000	-$71,709,000	-$51,209,000	-$36,613,000	-$36,572,000	-$36,613,000	-$18,286,000
		Earning Before Taxes		$38,911,000	$4,716,475	$41,638,338	$71,003,234	$95,157,453	$105,504,220	$116,575,001	$146,882,834
		Taxes(18.3%)		-$7,120,713	-$863,115	-$7,619,816	-$12,993,592	-$17,413,814	-$19,307,272	-$21,333,225	-$26,879,559
		Net Income/(Loss)		$31,790,287	$3,853,360	$34,018,522	$58,009,642	$77,743,639	$86,196,947	$95,241,776	$120,003,276
		Add back depreciation		$58,589,000	$100,409,000	$71,709,000	$51,209,000	$36,613,000	$36,572,000	$36,613,000	$18,286,000
	b	Total Operating Cash Flow		$90,379,287	$104,262,360	$105,727,522	$109,218,642	$114,356,639	$122,768,947	$131,854,776	$138,289,276
		Net Working Capital(9.5% of Sales Revenue)		$36,337,500	$39,179,456	$42,243,681	$45,547,559	$49,109,834	$52,950,714	$57,091,990	$61,557,154
	3)	Working Capital Cash Flow	($36,337,500)	($2,841,956)	($3,064,225)	($3,303,878)	($3,562,275)	($3,840,880)	($4,141,275)	($4,465,165)	$61,557,154
	4)	Cash Flow on salvage									$35,171,850
	CF=a+b+3)+4)	PROJECT NET CASH FLOW	($446,337,500)	$87,537,331	$101,198,135	$102,423,644	$105,656,367	$110,515,759	$118,627,672	$127,389,611	$235,018,280	SUM
	PV=CF/(1.072^N)	PRESENT VALUE OF NET CASH FLOW	($446,337,500)	$81,657,958	$88,060,863	$83,141,119	$80,004,890	$78,063,907	$78,165,893	$78,301,578	$134,754,526	$255,813,235
	NPV=Sumof PV	Net Present Value(NPV) of the Project	$255,813,235
		Salvage Falue of the fixed assets(After Tax)	$35,171,850