# Accounting Investment Projections

1. K Inc is looking at setting up a new manufacturing plant in Chicago. The company bought land 6 years ago for $7million in anticipation of using it as a warehouse and distribution site, but the company has decided to rent facilities elsewhere. The land would net $9.8 million if It were sold today. The company now wants to build its new manufacturing plant on this land; the plan will cost $21million to build and the site requires $850,000 worth of grading before it is suitable for construction. What is the proper cash flow amount to use as the initial investment in fixed assets when evaluating this project? Why?

2. A proposed new investment has projected sales of $825,000. Variable costs are 55% of sales, and fixed costs are $187,150; depreciation is $91,000. Prepare a pro forma income statement assuming a tax rate of 35%. What is the projected net income?

3. Consider the following income statement: Fill in the missing numbers and then calculate the OFC. What is the depreciation tax shield?

Sales $643,800

Costs 345,300

Depriciation 96,000

EBIT ?

Taxes (35%) ?

Net Income ?

4. Consider an asset that costs $780,000 and is depreciated straight line to zero over its 8 year tax life. The asset is to be used in a 5 year project; at the end of the project ; at the end of the project, the asset can be sold for $135,000. If the relevant tax rate is 35%, what is the after-tax cash flow from the sale of this asset?

5. C co. is considering a new 3 year expansion project that requires an initial fixed asset investment of $2.1 Million. The fixed asset will be depreciated straight line zero over its 3 year tax life, after which time it will be worthless. The project is estimated to generate $2,150,000 in annual sales, with costs of $1,140,000. If the tax rate is 35%, what is the OCF for this project?

6. In the previous problem, suppose the required return on the project is 14%. What's the project's NPV?

7. Auto Trans. Has the following estimates for its new gear assembly project: Price=$1070 per unit, variable cost=$290 per unit, fixed cost=4.8Million, quantity=70,000 units. Suppose the company believes all of its estimates are accurate only to within +- 15%. What values should the co. use for the 4 variables given here when it performs its best case scenario analysis? What about the worst case scenario?

8. For the company in the previous problem, suppose the management is most concerned about the impact of its price estimate on the projects profitability. How could you address this concern for Auto Trans.? Describe how you would calculate your answer. What values would you use for the other forecast variables?

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1. K Inc is looking at setting up a new manufacturing plant in Chicago. The company bought land 6 years ago for $7million in anticipation of using it as a warehouse and distribution site, but the company has decided to rent facilities elsewhere. The land would net $9.8 million if It were sold today. The company now wants to build its new manufacturing plant on this land; the plan will cost $21million to build and the site requires $850,000 worth of grading before it is suitable for construction. What is the proper cash flow amount to use as the initial investment in fixed assets when evaluating this project? Why?

Answer:

$7 million aquisiiton cost is a sunk cost

$9.8 million current after-tax value of the land is an opportunity cost if the land is used

$21 million cash outlay

$850,000 grading expenses

Cash flow = $9,800,000 + 21,000,000 + 850,000

= $31, 650, 000

2. A proposed new investment has projected sales of $825,000. Variable costs are 55% of sales, and fixed costs are $187,150; depreciation is $91,000. Prepare a pro forma income statement assuming a tax rate of 35%. What is the projected net income?

Answer:

Income statement:

Sales $825,000

Variable costs $ 453,750

Fixed costs $ 187,150

Depreciation $ 91,000

EBIT $ 93,100

Taxes at 35% $ 32,585

Net income $60,515

3. Consider the following income statement: Fill in the missing numbers and then calculate the OFC. What is the depreciation tax shield?

ANSWER:

Sales $643,800

Costs 345,300

Depriciation 96,000

EBIT 202,500

Taxes (35%) 70,875

Net Income 131,625

OCF = EBIT + depreciation - taxes

= $227,625

Depreciation tax shield = tax x depreciation = .35 x 96000 = 33,600

Increase in OCF by being able to expense depreciaiton

4. Consider an asset that costs $780,000 and is depreciated straight line to zero over its 8 year tax life. The asset is to be used in a 5 year project; at the end of the project ; at the end of the project, the asset can be sold for $135,000. If the relevant tax rate is 35%, what is the after-tax cash flow from the sale of this asset?

Answer:

Annual depreciation = 780,000/8 = 97,500

Accumulated depreciation = 5 x 97,500 = 487,500

BV5 = = 780,000 - 487,500 = 292,500

After tax salvage value = 135,000 + (292,500 - 135,000) x .35 = 190,125

Taxes on salvage value = (BV-MV) x Taxes(c)

5. C co. is considering a new 3 year expansion project that requires an initial fixed asset investment of $2.1 Million. The fixed asset will be depreciated straight line zero over its 3 year tax life, after which time it will be worthless. The project is estimated to generate $2,150,000 in annual sales, with costs of $1,140,000. If the tax rate is 35%, what is the OCF for this project?

Answer:

OCF = (sales - costs) x (1-Tc) + Tc x depreciation = ($2,150,000-$1,140,000)(1-.35) + .35 x( 2,100,000/3)

= $901,500

6. In the previous problem, suppose the required return on the project is 14%. What's the project's NPV?

Answer:

NPV = -2,100,000 + 901,500 x (PVIFA (14%, 3) = -$7,048.73

7. Auto Trans. Has the following estimates for its new gear assembly project: Price=$1070 per unit, variable cost=$290 per unit, fixed cost=4.8Million, quantity=70,000 units. Suppose the company believes all of its estimates are accurate only to within +- 15%. What values should the co. use for the 4 variables given here when it performs its best case scenario analysis? What about the worst case scenario?

Answer:

Scenario unit sales unit price unit variable cost fixed costs

Base case 70,000 $1070 $290 $4,800,000

Best case 80500 1230.5 246.5 4,080,000

Worst case 59500 909.5 333.5 5,520,000

8. For the company in the previous problem, suppose the management is most concerned about the impact of its price estimate on the projects profitability. How could you address this concern for Auto Trans.? Describe how you would calculate your answer. What values would you use for the other forecast variables?

Answer:

Estimate of the impact changes in price on the profitability of the project can be found from the sensitivity of NPV with respect to price -- calculated by finding the NPV at any two different price levels and forming the ratio of the changes in there parameters.

Whenever a sensitivity analysis is performed, all other variables are held constant at their base-case values.

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