Question

The president of Real Time Inc. has asked you to evaluate the proposed acquisition of a new computer. The computer's price is $50,000, and it falls into the MACRS 3-year class. Purchase of the computer would require an increase in spare parts inventory of $3,000. Accounts payable will also increase by $2,000. The computer would increase the firm's before-tax revenues by $20,000 per year but would also increase operating costs by $5,000 per year. Annual interest expense is $500 per year. The computer is expected to be used for 3 years and then be sold for $35,000. The firms marginal tax rate is 20 percent, and the project's cost of capital is 12 percent.

MACRS Depreciation rates are:

Year 1: 33%

Year 2: 45%

Year 3: 15%

Year 4: 7%

a). Refer to Real Time Inc. What is net investment required at t = 0?

b). Refer to Real Time Inc. What is the operating cash flow in Year 3?

c). Refer to Real Time Inc. What is the total value of the terminal year non-operating cash flow at the end of Year 3?

Answer 1

6.Net Investment Required = Purchase price of Computer + Working capital Investment

Net Investment Required = 50000 + 3000 - 2000

Net Investment Required = 51000

7. Operating cash Flow in Year 3 = (Incremental Revenue - Operating Costs -Annual interest Expense ) * (1 - tax) + Depreciation tax shield

Operating cash Flow in Year 3 = (20000 - 5000 -500) * (1 - 0.20) + 50000 * 15% * 20%

Operating cash Flow in Year 3 = 11600 + 1500

Operating cash Flow in Year 3 = $13100

8. Terminal Year Non operating cash Flows = return of Working Capital + Sale of assets - (Sale of Assets - (Book Value - Accumulated Depreciation) * Tax rate

Terminal Year Non operating cash Flows = 1000 + 35000 - (35000 - (50000 - 50000*93%)) * 20%

Terminal Year Non operating cash Flows = 1000 + 35000 - (35000 - 3500) * 20%

Terminal Year Non operating cash Flows = 29700

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