# 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

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).

Calculate after tax cash, NPV, IRR for a Windmill New Machine

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).

It is expected to have a useful life of 5 years and a salvage value of $1,000.

The engineering department has estimated that the new machine will reduce annual labor costs by 3,000

and cut the cost of waste materials by $2,000 per year. Also, because it is a new machine, the annual

maintenance costs will be $500 per year less than on the old one. Wee Willie uses straight-line depreciation

and is in the 40 percent corporate tax bracket. The tax rate applicable to gains and losses on the sale of

assets is the same as the corporate tax rate. Willie's WACC is 12 percent.

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

investment if Willie decides to go for it?

c) Calculate the NPV on this investment? Should Willie go for it? If yes, why? If not, why not? A

simple one-sentence explanation will do here.

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

firm usually makes. (No, I don't know why either, but that's his business). The firm uses RADR to

evaluate risky investments. Willie figures an appropriate risk premium for this investment is 5 percent.

Does this change the decision in part (c)? If yes, why? If not, why not? Show some figures and briefly

explain.