Question

1. Parker & Stone, Inc., is looking at setting up a new manufacturing plant in South Park to produce garden ools. The company bought some land 7 years ago for $5 million in anticipation of using it as a warehouse and distribution site, but the company has since decided to rent these facilities from a competitor instead. If the land were sold today, the company would net $9.8 million. The company wants to build its new manufacturing plant on this land; the plant will cost $12.2 million to build, and the site requires $882,000 worth of grading before it is suitable for construction.

Required :

What is the proper cash flow amount to use as the initial investment in fixed assets when evaluating this project?

2.

Consider an asset that costs $413,600 and is depreciated straight-line to zero over its 4-year tax life. The asset is to be used in a 2-year project; at the end of the project, the asset can be sold for $51,700.

  

Required :

If the relevant tax rate is 31 percent, what is the aftertax cash flow from the sale of this asset? (Do not round your intermediate calculations.)

3.  

Summer Tyme, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $3.672 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life, after which time it will be worthless. The project is estimated to generate $3,264,000 in annual sales, with costs of $1,305,600.

  

Required:

If the tax rate is 31 percent, what is the OCF for this project?

4.

Summer Tyme, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $5.616 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life, after which time it will have a market value of $436,800. The project requires an initial investment in net working capital of $624,000. The project is estimated to generate $4,992,000 in annual sales, with costs of $1,996,800. The tax rate is 31 percent and the required return on the project is 11 percent.

a)

What is the project's year 0 net cash flow?

b)

What is the project's year 1 net cash flow?

c)

What is the project's year 2 net cash flow?

d)

What is the project's year 3 net cash flow?

e)

What is the NPV?

5.

A 6-year project has an initial fixed asset investment of $42,000, an initial NWC investment of $4,000, and an annual OCF of -$64,000. The fixed asset is fully depreciated over the life of the project and has no salvage value.

  

Required:

If the required return is 19 percent, what is the project's equivalent annual cost, or EAC? (Do not round your intermediate calculations.)

Answer 1

1.

Amount of initial investment = Current market value of land + Cost of building plant + Cost of grading site

Amount of initial investment = $9.8 million + $12.20 million + $882,000 = $22,882,000

2.

Annual depreciation = Cost of asset/Useful life = $413,600/4 years = $103,400

Depreciation charged upto the end of year 2 = $103,400 * 2 = $206,800

Book value of asset at the end of 2 years = $413,600 - $206,800 = $206,800

Sale value of asset at the end of 2 years = $51,700

Loss on sale of asset = Book value – Sale value = $206,800 - $51,700 = $155,100

Tax savings on loss = $155,100 * 31% = $48,081

After – tax cash flow from sale of asset = Sale value of asset + Tax savings on loss on sale = $51,700 + $48,081 = $99,781