Question

O.J. Simpson plans to build a Park that runs for the next 25 years. O.J. would immediately need to start construction on the land which he bought 2 years ago. Current market value of the land is $4 million and is expected to be sold for $4 million at the end of year 25. $27.9 million need to be spend for computers and other equipment. Total salvage value of the equipment will be $2.9 million. A new building will cost $60 million and will have $10 million salvage value. The park could handle 5,000 visitors each day for 300 days a year, each paying $40 daily admission. O.J. will pay Freddy, the new manager, a salary of $3.3 million per year, $15 million per year for additional labor, and $3.7 million per year for utilities. O.J. will hire new lawyers to be paid $9.5 million per year. O.J. mentioned that his current lawyer, Monica Lewinski, could also help. Five years ago Monica signed 30-year contract promising annual salary of $2 million to provide unlimited legal services. She will not need any increase in her salary if she is also helping in Park. O.J. recently paid $0.7 million to Mr. McDougal’s firm for tax accounting advice. The average business tax rate is 40%. O.J. could depreciate the buildings and equipment on a straight line basis for 25 years. Last month O.J. hired Freddy’s girlfriend’s firm to make a marketing survey. She just billed him $0.4 million for that. If the Park opens then she will continue to provide unlimited marketing services to the Park for $0.5 million annually. O.J. will need a working capital of $20 million immediately. This amount will be recovered at the termination of the business. O.J. has only $2.7 million and the rest of the money needed to finance the project will be borrowed from a bank. The loan will be amortized for over the life of the project and the interest will be 10.7%. O.J’s required rate of return is 13.85%. What is the incremental third year operating cash flow?

		A.  $1.9 million
		B.  $18 million
		C.  $24 million
		D.  $25 million
		E.  $57.9 million

Answer 1

Equipment
Cost = 27.9 Million
Salvage Value = 2.9 Million
Life = 25 Years
Dep = (27.9-2.9)/25 = 1 Million

Building
Cost = 60 Million
Salvage Value = 10 Million
Life = 25 Years
Dep = (60 - 10)/25 = 2 Million

Revenue = No. of VIsitor each day * No. of operating days in year * Charge per visitor
Revenue = 5000*300*40
Revenue = 60,000,000 or 60 Million

Expenses = Manager Salary + Additional Labor + Utilities + New lawyer + Marketing Services + Depreciation
Expenses = 3.3+15+3.7+9.5+0.5 + (1+2)
Expenses = 35 Million

Income Before Tax = 60 - 35 = 25 Million
Tax = 25 * 40% = 10 Million
Net Income = 25 - 10 = 15 Million

Operating Cash Flows = Net Income + Depreciation
Operating Cash Flows = 15 + (1 + 2)
Operating Cash Flows = 18 Million

Option B 18 Million