Question

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?

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