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Computing cash flow analysis with NPV

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In the current year ( year 0), Amisha became a shareholder in Sultan Inc., a calendar year S corporation, by contributing $15,000 cash in exchange for stock. Shortly before the end of the year, Sultan's CFO notified Amisha that her pro rata share of ordinary loss for the year would be 55,000. Amisha immediately loaned $40,000 to Sultan in exchange for a two-year, interest-bearing corporate note. Consequently, she had enough stock and debt basis to allow her to deduct the $55,000 loss on her current year return.

Compute the NPV of Amish's cash flow associated with her loan in the following three cases. In each case, assume she has a 35 percent marginal tax rate on ordinary income, a 15 percent on capital gains, and uses a 6 percent discount rate.

a. For the next two years (year 1 and 2), Amisha share of Sultans ordinary income totaled $49,000, and sultan did not distribute any cash to its shareholders. However, it did repay the $40,000 loan plus $3,800 interest in year 2.

b. For the next two years (year 1 and year 2), Amisha share of Sultan ordinary income totaled $19,100, and Sultan did not distribute any cash of its shareholders. However, it did repay the $40,000 loan plus 3,800 interest year 2.

c. For the next two years (year 1 and year 2), Amisha share of Sultans ordinary loss totaled $11,400. In year 2, the corporation declared bankruptcy and defaulted on all its debts, including the loan from Amisha.

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This solution provides calculations for cash flow analysis in Excel.

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Discounted Cash Flow Analysis

A sports nutrition company is examining whether a new high-performance sports drink should be added to its product line. A preliminary feasibility analysis indicated that the company would need to invest $17.5 million in a new manufacturing facility to produce and package the product. A financial analysis using sales and cost data supplied by marketing and production personnel indicated that the net cash flow (cash inflows minus cash outflows) would be $6.1 million in the first year of commercialization, $7.4 million in year two, $7.0 million in year three, and 5.5 million in year 4.

Senior company executives were undecided whether to move forward with the development of the new product. They requested that a discounted cash flow analysis be performed using two discount rates: 20 percent and 15 percent.

a. Should the company proceed with the development of the product if the discount rate is 20 percent? Why?

b. Should the company proceed with the development of the product if the discount rate is 15 percent? Why?

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