Question

A firm is deciding on a new project. Use the following information for the project evaluation...

A firm is deciding on a new project. Use the following information for the project evaluation and analysis:

- The initial costs are \$900,000 for fixed assets. The fixed assets will be depreciated straight line to a zero book value over the 3-year life of the project. The fixed assets have an estimated salvage value of \$60,000 at the end of the project.

- The project also requires an additional \$200,000 for net working capital. All of the net working capital will be recouped at the end of the 3 years.

- The project is expected to generate sales of \$2,000,000 (2,000 units at a sales price of \$1,000/unit), incur total costs of \$1,500,000 per year (comprised of variable cost of \$500 per unit and fixed costs of \$500,000).

- The firm’s marginal tax rate is 40 percent.

- The company has 50,000 shares of common stock outstanding at a market price of \$25 a share. The stocks have a beta of 1.5. The risk free rate is 1%, and the market risk premium is 10%.

- There are 1,000 bonds outstanding which mature in 13 years, have a face value per bond of \$1,000, and are currently quoted at \$1,250 each. The bonds have a coupon rate of 10 percent.

- The target capital structure is 50% debt and 50% equity.

a) What is the Operating Cash Flow for each year of the project?

b) What is the after-tax salvage value at the end of this project?

Homework Answers

Answer #1

a) Depreciation = cost /useful life

= 900000/3

=300000

 Net Income Revenue 2,000,000 less:expense (1,500,000) EBIT 500,000 Less:Interest on debt [1000*1000*.10] (100,000) EBT 400,000 Less:tax [400000*.40] (160000) Net income 240000

Operating cash flow = EBIT - Taxes+ depreciation

= 500000- 160000+300000

= 640000

**assuming fixed cost includes depreciation

b)After tax salvage : salvage [1-tax]

60000[ 1-.40]

36000

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