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# Computing Project Cash Flow

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You are analyzing a proposed 4-year project. You expect to sell 20,000 units per year at an average selling price of \$5 per unit. The initial cash outlay for fixed assets will be \$120,000. These assets will be depreciated straight-line to a zero book value over the life of the project. The fixed assets will be worthless at the end of the project. Fixed costs are expected to be \$8,000 and variable costs will be \$1.90 per unit. The project requires an initial investment in net working capital of \$10,000 which will be recovered in full at the end of the project's life. What is the project's cash flow for year 4 if the tax rate is 35 percent?
\$24,000
\$34,000
\$45,600
\$55,600

The most valuable alternative that is forfeited if a particular investment is undertaken is called:
a side effect.
erosion.
a sunk cost.
an opportunity cost.
a marginal cost.

#### Solution Preview

The project's Year 4 cash flows will be:

Sales \$100,000 (20,000 units*\$5/unit)
Variable costs ( 38,000) (20,000 units*\$1.90/unit)
Fixed costs ( 8,000) ...

#### Solution Summary

This solution illustrates how to compute a project's after-tax cash flow and discloses most valuable alternative that is forfeited if a particular investment is undertaken is called.

\$2.19
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## Capital Budgeting and Cash Flow

Please assist me with the problems below.

3. The Cooper Electronics Company has developed the following schedule of potential investment projects that may be undertaken during the next six months:
Project Cost (in Millions of Dollars) Expected Rate of Return
A \$ 3.0 20%
B. 1.5 22
C 7.0 7
D 14.0 10
E. 50.0 12
F. 12.0 9
G. 1.0 44

a. If Cooper requires a minimum rate of return of 10 percent on all investments, which projects should be adopted?
b. In general, how would a capital budgeting constraint on the available amount of investment funds influence these decisions?
c. How would differing levels of project risk influence these decisions?

10. Nguyen, Inc., is considering the purchase of a new computer system (ICX) for \$130,000. The system will require an additional \$30,000 for installation. If the new computer is purchased it will replace an old system that has been fully depreciated. The new system will be depreciated over a period of 10 years using straight-line depreciation. If the ICX is purchased, the old system will be sold for \$20,000. The ICX system, which has a useful life of 10 years, is expected to increase revenues by \$32,000 per year over its useful life. Operating costs are expected to decrease by \$2,000 per year over the life of the system. The firm is taxed at a 40 percent marginal rate.
a. What net investment is required to acquire the ICX system and replace the old system?
b. Compute the annual net cash flows associated with the purchase of the ICX system.

4. Jefferson Products, Inc., is considering purchasing a new automatic press brake, which costs \$300,000 including installation and shipping. The machine is expected to generate net cash inflows of \$80,000 per year for 10 years. At the end of 10 years, the book value of the machine will be \$0, and it is anticipated that the machine will be sold for \$100,000. If the press brake project is undertaken, Jefferson will have to increase its net working capital by \$75,000. When the project is terminated in 10 years, there will no longer be a need for this incremental working capital, and it can be liquidated and made available to Jefferson for other uses. Jefferson requires a 12 percent annual return on this type of project and its marginal tax rate is 40 percent.
a. Calculate the press brake's net present value.
b. Is the project acceptable?
c. What is the meaning of the computed net present value figure?
d. What is the project's internal rate of return?
e. For the press brake project, at what annual rates of return do the net present value and internal rate of return methods assume that the net cash inflows are being reinvested?

A \$1,230 investment has the following expected cash returns:
Year Net Cash Flow
1 \$800
2 200
3 400
Compute the internal rate of return for this project.

4. Two projects have the following expected net present values and standard deviations of net present values:

Project Expected Net Present Value Standard Deviation
A \$50,000 \$20,000
B 10,000 7,000

a. Using the standard deviation criterion, which project is riskier?
b. Using the coefficient of variation criterion, which project is riskier?
c. Which criterion do you think is appropriate to use in this case? Why?

5. American Steel Corporation is considering two investments. One is the purchase of a new continuous caster costing \$100 million. The expected net present value of this project is \$20 million. The other alternative is the purchase of a supermarket chain, also costing \$100 million. It, too, has an expected net present value of \$20 million. The firm's management is interested in reducing the variability of its earnings.
a. Which project should the company invest in?
b. What assumptions did you make to arrive at this decision?

10. Apple Jacks, Inc., produces wine. The firm is considering expanding into the snack food business. This expansion will require an initial investment in new equipment of \$200,000. The equipment will be depreciated on a straight-line basis over a 10-year period to zero. At the end of the project the equipment is estimated to have a salvage value of \$50,000.
The expansion will also require an increase in working capital for the firm of \$40,000. Revenues from the new venture are forecasted at \$200,000 per year for the first 5 years and \$210,000 per year for years 6 through 10. Operating costs exclusive of depreciation from the new venture are estimated at \$90,000 for the first 5 years and \$105,000 for years
6 through 10. It is assumed that at the end of year 10, the snack food equipment will be sold for its estimated salvage value. The firm's marginal tax rate is 40 percent. The required return for projects of average risk has been estimated at 15 percent.
a. Compute the project's net present value, assuming that it is an average-risk investment.
b. If management decides that all product line expansions have above-average risk and therefore should be evaluated at a 24 percent required rate of return, what will be the risk-adjusted net present value of the project?

11. The Seminole Production Company is analyzing the investment in a new line of business machines. The initial outlay required is \$35 million. The net cash flows expected from the investment are as follows:
Year Net Cash Flow (Million)
1 \$ 5
2 8
3 15
4 20
5 15
6 10
7 4
The firm's cost of capital (used for projects of average risk) is 15 percent.
a. Compute the net present value of this project assuming it possesses average risk. Because of the risk inherent in this type of investment, Seminole has decided to employ the certainty equivalent approach. After considerable discussion, management has agreed to apply the following certainty equivalents to the project's cash flows:
Year cx _ t
0 1.00
1 0.95
2 0.90
3 0.80
4 0.60
5 0.40
6 0.35
7 0.30
If the risk-free rate is 9 percent, compute the project's certainty equivalent net present value.
c. On the basis of the certainty equivalent analysis, should the project be accepted?

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