Question

1.Sheridan Potions, Inc., a pharmaceutical company, bought a machine at a cost of $2 million five years ago that produces pain-reliever medicine. The machine has been depreciated over the past five years, and the current book value is $760,000. The company decides to sell the machine now at its market price of $1 million. The marginal tax rate is 30 percent.

*What are the relevant cash flows?:

*How do they change if the market price of the machine is $600,000 instead?:

2.Blossom, Inc., is considering investing in a new production line for eye drops. Other than investing in the equipment, the company needs to increase its cash and cash equivalents by $10,000, increase the level of inventory by $33,000, increase accounts receivable by $25,000, and increase accounts payable by $5,000 at the beginning of the project. Blossom will recover these changes in working capital at the end of the project 9 years later. Assume the appropriate discount rate is 10 percent. What are the present values of the relevant investment cash flows?

*Present Value?:

Answer 1

1

a

Book value = (purchase price-Final book value)*remaining life/total life+final book value
= (2000000-760000)*0/5+760000
= 760000
After tax salvage value = selling price*(1-tax rate)+book value*tax rate
=1000000*(1-0.3)+760000*0.3
=928000

b

Book value = (purchase price-Final book value)*remaining life/total life+final book value
= (2000000-760000)*0/5+760000
= 760000
After tax salvage value = selling price*(1-tax rate)+book value*tax rate
=600000*(1-0.3)+760000*0.3
=648000

2

Increase in working capital = increase its cash and cash equivalents+increase the level of inventory+increase accounts receivable-increase accounts payable = 10000+33000+25000-5000=63000

PV = -Working capital + working cap/(1+r)^n

=-63000+63000/(1+0.1)^9

=-36281.85