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    Calculating the Capital Investment

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    A. Warren Company plans to open a new repair service center for one of its electron products. The center requires an investment in depreciable assets costing $480000. The asset will be depreciated on a straight-line basis, over four years, and have no expected salvage value. The annual income statement for the center is given below:

    Revenues $360000
    Less: cash operating expenses -150000
    Depreciation -120000
    Income before income taxes $90000
    Less: income taxes (40%) 36000
    Net income $54000

    1. Using the income approach, calculate the after tax cash flows.
    2. Using the decomposition approach, calculate the after-tax cash flows for each item of the income statement and show that the total is the same as the income approach.
    3. What if is it desirable to express the decomposition approach in a spreadsheet format for the four years to facilitate the use of spreadsheet software packages? Express the decomposition approach in a spreadsheet format, with a column for each income item and total column.

    B. Each of the following scenarios is independent. All cash flows are after-tax cash flows.
    1. W corp. is considering the purchase of a computer-aided manufacturing system. The cash benefits will be $600000/yr. the system costs $3600000 and will last 8 yrs. compute the NPV assuming a discount rate of 10%. Should the company buy the new system?
    2. N Corp has just invested $540000 in a restaurant specializing in German food. It expects t receive $86940/yr for the next 8 yrs, the company's cost of capital is 5.5%. Compute the internal rate of return. Did N corp. make a good decision?

    C. A hospital is considering the possibility of two new purchases: new MRI equipment and new biopsy equipment. Each price requires an investment of $850000. The expected life for each is 5 yrs with no expected salvage value. The net cash inflows associated with the two independent projects are as follows:
    Year MRI Equipment Biopsy Equipment
    1 $400000 $100000
    2 200000 100000
    3 300000 200000
    4 200000 400000
    5 100000 475000
    1. Compute the payback period for each project. Assume that the manager of the hospital accepts only projects with a payback period of 3 yrs or less. Offer some reasons why this may be a rational strategy.
    2. Compute the accounting rate of return for each project.

    D. Required: (independent cases)

    1. Hal Stunt Company is investing $120000 in a project that will yield a uniform series of cash inflows over the next four years. If the internal rate of return is 14%, how much cash inflow per year can be expected?
    2. Warner medical clinic has decided to invest in some new blood diagnostic equipment. The equipment will have a three-year life and will produce a uniform series of cash savings. The net present value of the equipment is $1750, using the discount rate of 8%. The internal rate of return is 12%. Determine the investment and the amount of cash savings realized each year.
    3. A new lathe costing $60096 will produce savings of $12000/yr. how many yrs must be the lathe last if an IRR of 18% is realized?
    4. The NPV of a new product is $6075. the product has a life of four years and produces the following cash flows:

    Year 1 $15000
    Year 2 20000
    Year3 30000
    Year 4 ?
    The cost of the project is three times the cash flow produced in year 4. The discount rate is 10%. Find the cost of the project and the cash flow for year 4.

    E. Postman Company is considering two independent projects. One project involves a new product line, and the other involves the acquisition of forklifts for the materials handling department. The projected annual operating revenues and expenses are as follows:

    Project 1
    Revenues $270000
    Cash expenses -135000
    Depreciation -45000
    Income before income taxes 90000
    Income taxes -36000
    Net income 54000

    Project 2
    Cash expenses $90000
    Depreciation 90000

    Compute the after-tax cash flows for each project. The tax rate is 40% and includes federal and state assessments.

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    Solution Summary

    The solution calculates the capital investment.