Calculating cash flows, after-tax salvage value, NPV and IRR
Input Data from the case:
Equipment cost
Shipping charge
Installation charge
Economic Life
Salvage Value
Tax Rate
Cost of Capital
Units Sold
Sales Price Per Unit
Incremental Cost Per Unit
Inventory/sales
Inflation rate
a. Prepare a depreciation schedule. What is Shrieves' depreciable basis? What are the annual depreciation expenses?
Annual Depreciation Expense Schedule
Depreciable Basis =
Year % x Basis = Depr. Exp Remaining Book Value
1st
2nd
3rd
4th
b. Construct annual incremental operating cash flow statements.
Annual Operating Cash Flows
1st Year 2nd Year 3rd Year 4th Year
Units
Unit price
Unit cost
Sales
Costs
Depreciation
Operating income before taxes (EBIT)
Taxes (40%)
Net operating profit after taxes
Depreciation
Net Operating Cash Flow (CF)
c. Estimate the required net operating working capital for each year, and the cash flow due to investments in net operating working capital.
Annual Cash Flows due to Investments in Net Operating Working Capital (NOWC)
Present Period (0) 1st Year 2nd Year 3rd Year 4th Year
Sales
NOWC (% of sales) required
CF (required) due to investment in NOWC
d. Calculate the after-tax salvage cash flow.
After-tax Salvage Value
Based on facts in case:
Salvage Value
Book value
Gain or loss
Tax on Salvage Value
Net Terminal Cash Flow (Salvage CF)
e. Calculate the net cash flows for each year. Based on these cash flows, what are the project's NPV and IRR? Do these indicators suggest that the project should be undertaken?
Projected Net Cash Flows
Present Period (0) 1st Year 2nd Year 3rd Year 4th Year
Investment Outlay: Long Term Assets
Net Operating Cash Flow (CF)
CF (required) due to investment in NOWC
Salvage Cash Flows
Net Cash Flows
NPV
IRR
This question has the following supporting file(s):
- Assessment.doc
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Solution Summary
This solution is comprised of detailed calculation using excel of annual cash flows, after-tax salvage value of the asset, projected net cash flows, the net present value (NPV), and internal rate of return (IRR).
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Extracted Content from Question Files:
- Assessment.doc
Assessment # 3: Capital Budgeting.
Data Case: Shrieves Casting Company is considering adding a new line
to its product mix, and the capital budgeting analysis is being
conducted by Sidney Johnson, a recently graduated MBA. The
production line would be set up in unused space in Shrieves' main
plant. The machinery’s invoice price would be approximately
$200,000; another $10,000 in shipping charges would be required;
and it would cost an additional $30,000 to install the equipment. The
machinery has an economic life of 4 years, and Shrieves has obtained
a special tax ruling which places the equipment in the MACRS 3-year
class. The machinery is expected to have a salvage value of $25,000
after 4 years of use.
The new line would generate incremental sales of 1,250 units per year
for four years at an incremental cost of $100 per unit in the first year,
excluding depreciation. Each unit can be sold for $200 in the first
year. The sales price and cost are expected to increase by 3% per
year due to inflation. Further, to handle the new line, the firm’s net
operating working capital would have to increase by an amount equal
to 12% of sales revenues. The firm’s tax rate is 40 percent, and its
overall weighted average cost of capital is 10 percent. Prepare a
capital budgeting analysis and answer the following questions.
a. Prepare a depreciation schedule. What is Shrieves' depreciable
basis? What are the annual depreciation expenses?
b. Construct annual incremental operating cash flow statements.
c. Estimate the required net operating working capital for each year,
and the cash flow due to investments in net operating working capital.
d. Calculate the after-tax salvage cash flow.
e. Calculate the net cash flows for each year. Based on these cash
flows, what are the project’s NPV and IRR? Do these indicators
suggest that the project should be undertaken?
Must show all necessary data points, equations and computations
accurately to earn maximum point.
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