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Calculating cash flows, after-tax salvage value, NPV and IRR

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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

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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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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The Wee Willie Windless Windmill Corporation is considering the replacement of a machine that was purchased five years ago for $10,000. At the time of the purchase it was expected to have a useful life of 10 years and no salvage value. Wee Willie has located a smaller firm that would purchase the used machine for $6,000 if Willie decides to buy a new one.

The new machine under consideration will cost $16,000 (including all transportation and installation costs).
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a) Calculate the net initial after-tax cash outlay (ICO) required for this investment?

b) Calculate the expected annual incremental after-tax cash flows that will be derived from this
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c) Calculate the NPV on this investment? Should Willie go for it? If yes, why? If not, why not? A
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d) Without doing any calculations, is the IRR on this investment higher or lower than 10 percent?

e) Now, assume that Wee Willie considers this investment to be more risky than other investments the
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