财务管理基础答案im11CashFlowEstimationandR

Chapter11CashFlowEstimationandRiskAnalysisLEARNINGOBJECTIVESAfterreadingthischapter,studentsshouldbeableto:Discuss difficultiesandrelevantconsiderationsinestimatingnetcashflows, andexplaintheDiscuss difficultiesandrelevantconsiderationsinestimatingnetcashflows, andexplainthefour majorwaysthatprojectcashflowdiffersfromaccountingincome.Definethe following terms:relevantcashflow,incrementalcashflow,sunkcost,opportunitycost,externalities,andcannibalization.?Identify thethree categories toclassified.whichincrementalcashflowscanbe?Analyze anexpansion project andmakeadecisionshouldbeacceptedonthebasisofstandardcapitalbudgetingtechniques.whethertheproject?Explain three reasons whycorporatestockholdersarewelldiversified.riskis importantevenifafirm's?Identifytworeasonswhystand-aloneriskisimportant.?Demonstrate sensitivity andscenarioanalyses andexplainMonteCarlosimulation.Discussthetwomethodsusedtoincorporateriskintocapital budgetingdecisions.

LECTURESUGGESTIONSThischaptercoverssomeimportantbutrelativelytechnicaltopics.Notetoothatthischapterismoremodular than most,i.e.,thediscrete,hencetheycanbeomittedwithoutlossofcontinuity.Therefore,ifyouareexperiencingatimecrunch,youcouldskipsectionsofthechapter.Assumingyouaregoingtocovertheentirechapter,thedetailsofwhatwecover,andthewaywecoverit,canbeseenbyscanning11.Forother suggestions aboutthelecture, pleaseSuggestions”inChapter2,wherewedescribehowweconductourclasses.majorsectionsareBlueprints,Chapterseethe"LectureDAYSONCHAPTER:3OF58DAYS(50-minuteperiods)majorsectionsareBlueprints,Chapterseethe"Lecture11-1Onlycashcanbespent orreinvested,andsince accountingprofitsdo11-311-4notrepresentcash,theyareofless fundamentalflowsfor investment analysis. Recallthatinchapterwefocusedondividends,whichrepresentcashflows,ratherthanimportaneethestockthan cashvaluationCapitalbudgetinganalysisshouldonly includethosecashflows thatwill beaffectedbythe decision.Sunkcostsareunrecoverable andcannot bechanged,sotheyhavenobearing onithecapitalbudgetingdecision.Opportunitycostsrepresent thecashflowsthefirmgivesupbyinvestinginthisprojectratherthanitsnextbestalternative,andexternalitiesarethecashflows(both positiveandnegative)jectsthatresultfromthefirmtakingonthisproject.Thesecashflowsoccuronlybecausethefirmtookonthecapitalbudgetingproject;therefore,theymustbeincludedintheanalysis.Whenafirmtakesonanewcapitalbudgetingproject,ittypicallymustincrease its investment inreceivablesandinventories, overandabovetheincreaseinpayablesandaccruals,thusincreasingitsnetoperatingworking capital(NOWC).Sincethisincreasemustbefinanced, itisincluded asanoutflowinYear0oftheanalysis. Attheendoftheproject'slife,inventoriesaredepletedandreceivablesarecollected.Thus,thereisadecreaseinNOWC,whichistreatedasaninflowinthefinalyearoftheproject 'slife.Simulation analysis involves workingwith continuous probabilitydistributions,andtheoutputofasimulationanalysisisadistributionofnet present valuesorratesofreturn. Seenariopickingseveralpointsonthevariousprobabilitydeterminingcashflowsorratesofreturnforthesepoints.Sensitivityanalysis involves determining theextenttowhichgivenachangeinoneparticularinputvariable.Simulationanalysisisexpensive. Therefore,itwouldmorethanlikelydecision forthe$200millioninvestmentinasatellitesystemthaninthedecisionforthe$12,000truck.analysis involvesdistributions andcashflows change,beemployed inthe11-1Equipment$9,000,000NOWCInvestment3,000,000Initialinvestmentoutlay$12,000,00011-2OperatingCashFlows:t=1Salesrevenues$10,000,000Operatingcosts7,000,000Depreciation2,000,000Operatingincomebeforetaxes$1,000,000Taxes(40%)400,000Operatingincomeaftertaxes$600,000Addbackdepreciation2,000,000Operatingcashflow$2,600,000$20,000,00016,000,000$4,000,00011-3Equipment'$20,000,00016,000,000$4,000,000BookvalueGainonsale=$5,000,000-$4,000,000=$1,000,000.Taxongain=$1,000,000(0.4)=$400,000.ATnetsalvagevalue=$5,000,000-$400,000=$4,600,000.11-4E(NPV)=0.05(-$70)+0.20(-$25)+0.50($12)+0.20($20)+0.05($30)=-$3.5+-$5.0+$6.0+$4.0+$1.5=$3.0million.npv=[0.05(-$70-$3)0.20($20-$3)=$23.622million.2+0.20(-$25-$3)2+0.05($30-$3)2+0.50($12-$3)2]?CV心丝7.874.$3.011-5a. 012345Initialinvestment($250,000)Netoper.WC(25,000)CostsavingsDepreciationCostsavingsDepreciationOper.inc.beforetaxesTaxes(40%)Oper.Inc.(AT)Add:DepreciationOper.CF$90,000$90,000$90,000$90,000$90,00082,500112,50037,500 17,500 0$7,500($22,500)$52,500$72,500$90,0003,000 (9,000)21,00029,000 36,000$4,500($13,500)$31,500$43,500$54,00082,500112,500 37,500 17,500 0$87,000$99,000$69,000$61,000$54,000ReturnofNOWC $25,000SaleofMachine 23,000Taxonsale(40%) (9,200)Netcashflow($275,000)$87,000$99UD0$69,000$"61,000$92800NPV=$37,035.13Notes:aDepreciationSchedule,Basis=$250,000MACRSRateBasis=YearBeg.Bk.ValueMACRSRateDepreciationEndingBV1$250,0000.33$82,500$167,5002167,5000.45112,50055,000355,0000.1537,50017,500417,5000.0717,5000$250,000b.Ifsavingsincreaseby20percent,thensavingswillbe(1.2)($90,000)=$108,000.Ifsavingsdecreaseby20percent,thensavingswillbe(0.8)($90,000)=$72,000.(1)Savingsincreaseby20%:012345Initialinvestment($250,000)Netoper.WC(25,000)CostsavingsDepreciationOper.inc.beforetaxesTaxes(40%)Oper.Inc.(AT)Add:DepreciationOper.CF$108,000$108,000$108,000$108,000$108,00082,500112,500 37,500 17,500 0$25,500($4,500)$70,500$90,500$108,00010,200 (1,800)28,200 36,20043,200$15,300($2,700)$42,300$54,300$64,80082,500112,500 37,500 17,500 0$97,800$109,800$79,800$71,800$64,800ReturnofNOWC$25,000SaleofMachine23,000Taxonsale(40%)Netcashflow (9,200) ($275,000)$97,800$109,800$79,800$力800$103,600 -NPV=$77,975.63(2)Savingsdecreaseby20%:012345Initialinvestment($250,000)Netoper.WC(25,000)CostsavingsDepreciationOper.inc.beforetaxesTaxes(40%)Oper.Inc.(AT)$72,000$72,000$72,000$72,000$72,00082,500112,500 37,500 17,500 0($10,500)($40,500)$34,500$54,500$72,000(4,200)(16,200)13,80021,80028,800($6,300)($24,300)$20,700$32,700$43,200Add:DepreciationOper.CF82,500112,500 37,500 17,500 0$76,200$88,200$58,200$50,200$43,200ReturnofNOWCSaleofMachine$25,00023,000Taxonsale(40%)Netcashflow($275,000)$76,200$88,200(9,200)$58,200$50,200$82,000NPV=-$3,905.37c.Worst-casescenario:012Initialinvestment($250,000)Netoper.WC(30,000)CostsavingsDepreciationOper.inc.beforetaxes$72,000$72,000$72,000$72,000$72,00082,500112,500 37,500 17,500 0($10,500)($40,500)$34,500$54,500$72,000Taxes(40%)Oper.Inc.(AT)Add:DepreciationOper.CF(4,200)(16,200)13,80021,80028,800($6,300)($24,300)$20,700$32,700$43,20082,500112,500 37,500 17,500 0$76,200$88,200$58,200$50,200$43,200ReturnofNOWCSaleofMachine$30,00018,000Taxonsale(40%)Netcashflow($280,000)$76,200$88,200(7,200)$58,200$50,200$84,000NPV=-$7,663.52Base-casescenario:Thiswasworkedoutinparta.NPV=$37,035.13.Best-casescenario:012Initialinvestment($250,000)Netoper.WC(20,000)CostsavingsDepreciationOper.inc.beforetaxesTaxes(40%)Oper.Inc.(AT)Add:DepreciationOper.CF$108,000$108,000$108,000$108,000$108,00082,500112,500 37,500 17,500 0$25,500($4,500)$70,500$90,500$108,00010,200 (1,800)28,200 36,20043,200$15,300($2,700)$42,300$54,300$64,80082,500112,500 37,500 17,500 0$97,800$109,800$79,800$71,800$64,800ReturnofNOWC$20,000SaleofMachine28,000Taxonsale(40%)(11,200)Netcashflow($270,000)$97,800$109,800$79,800$71,800$101,600NPV=$81,733.79Prob.NPVProb. NPVWorst-case0.35($7,663.52)($2,682.23)Base-case0.3537,035.1312,962.30Best-case0.3081,733.7924,520.14E(NPV)$34,800.21npv=[(0.35)(-$7,663.52-$34,800.21)2+(0.35)($37,035.13-$34,800.21)2+(0.30)($81,733.79-$34,800.21)2]?npv=[$631,108,927.93+$1,748,203.59+$660,828,279.49]NPV=$35,967.84.CV=$35,967.84/$34,800.21=1.03.11-6a.Theapplicabledepreciationvaluesareasfollowsforthetwoseenarios:b.Tofindthediffereneeinnetpresentvaluesunderthesetwomethods,incrementalwemustdeterminemethodprovides.subtractedfromdepreciationfrom Revenueseachcomputed Then,togettheprojectexpense.togetdepreciationthe differeneeThedepreciationother,asThefulloperatingisintheredepreciationincome,addedtoexpensesaretaxandafter-tax'soperatingcashflow.Therefore,ifthetaxratecashcannotramificationsexpenseisthen taxesoperatingb.Tofindthediffereneeinnetpresentvaluesunderthesetwomethods,incrementalwemustdeterminemethodprovides.subtractedfromdepreciationfrom Revenueseachcomputed Then,togettheprojectexpense.togetdepreciationthe differeneeThedepreciationother,asThefulloperatingisintheredepreciationincome,addedtoexpensesaretaxandafter-tax'soperatingcashflow.Therefore,ifthetaxratecashcannotramificationsexpenseisthen taxesoperatingflowseachsimplybeduetosubtracteddueareincomeis40%,only 60%oftheoutduringtheafter-taxdepreciation expenseisdepreciationoperatingaddedbackexpenseisactuallyincome calculationtoget operatingsubtractedandthefullincome. So,thereisataxbenefitassociatedwiththedepreciationexpensethatamountsto40%thereisataxbenefitassociatedwiththedepreciationexpensethatamountsto40%ofthedepreciation expense.differencesbetweendepreciationexpensesundereachscenarioshouldTherefore, thebecomputedandmultipliedbythedepreciationexpense.by0.4todeterminethebenefitprovidedbecomputedandmultipliedbythedepreciationexpense.by0.4todeterminethebenefitprovidedYearSeenario1(straight-line)Scenario2(MACRS)1$200,000$264,0002200,000360,0003200,000120,0004200,00056,000YearDepr.Exp.Differenee(2-1)Depr.Exp.Diff.0.4(MACRS)1$64,000$25,6002160,00064,0003-80,000-32,0004-144,000-57,600Nowtofind the differeneein NPVtobegeneratedunder thesescenarios,justenterthecashflowsthatrepresentthebenefitfromdepreciation expenseandsolvefornetpresentvaluebaseduponaWACCof10%.

CFo= 0CFi=25600CF2=64000CF3=-32000CF4=-57600=10depreciationmethodNPV=$12,781.64depreciationmethodSo,allelseequaltheuseoftheacceleratedwillresultinahigherNPV(by$12,781.64)thanwouldtheuseofastraight-linedepreciationmethod.11-7a.Thenetcostis$178,000:Costofinvestmentatt=0:Baseprice ($140,000)Modification (30,000)IncreaseinNOWC (8,000) Cashoutlayfornewmachine ($178,000)Theoperatingcashflowsfollow:Year1Year2Year3 After-taxsavings $30,000$30,000$30,000Depreciationtaxsavings 22,44030,60010,200 Netoperatingcashflow$52,440$60,600$40,200Notes:1.Theafter-tax costsavingsis$50,000(1 —T)= $50,000(0.6)$30,000.2.Thedepreciation expenseineachyearisthedepreciablebasis,$170,000,timestheMACRSallowaneepercentagesof0.33,0.45,and0.15forYears1,2,and3,respectively.DepreciationexpenseinYears1, 2,and3is$56,100, $76,500,and$25,500.Thedepreciationtaxsavingsiscalculatedasthetaxrate(40percent)timesthedepreciationexpenseineachyear.Theterminalcashflowis$48,760:Salvagevalue$60,000TaxonSV* (19,240)ReturnofNOWC 8,000$48,760RemainingBVinYear4=$170,000(0.07)=$11,900.*TaxonSV=($60,000-$11,900)(0.4)=$19,240.

TheprojecthasanNPVof($19,549).Thus,itshouldnotbeaccepted.YearNetCashFlowPV@12%0($178,000)($178,000)152,44046,821260,60048,310388,96063,320NPV=($19,549)Alternatively,placethecashflowsonatimeline:0111212%3111-178,000152,440160,600 40,20048,76088,960Withafinancialcalculator,input theappropriate cashflows intothecashflowregister, inputI=12,andthensolve forNPV=$19,548.65-$19,549.11-8a.Thenetcostis$126,000:Price ($108,000)Modification (12,500)IncreaseinNOWC (5,500)Cashoutlayfornewmachine($126,000)Theoperatingcashflowsfollow:Year1Year2Year3 After-taxsavings$28,600$28,600$28,600Depreciationtaxsavings13,91818,979 6,326Netcashflow $42,518$47,579$34,926Notes:Theafter-taxcostsavingsis$44,000(1-T)=$44,000(0.65)=$28,600. Thedepreciation expenseineachyearisthedepreciablebasis, Thedepreciation expenseineachyearisthedepreciablebasis,$120,500,timestheMACRSallowaneepercentagesof0.33,0.45,and0.15forYears1,2,and3,respectively.DepreciationexpenseinYears1, 2,and3is$39,765, $54,225,and$18,075.Thedepreciationtaxsavingsiscalculatedasthetaxrate(35percent)timesthedepreciationexpenseineachyear.Theterminalcashflowis$50,702:Salvagevalue$65,000TaxonSV* (19,798)ReturnofNOWC 5,500$50,702BVinYear4=$120,500(0.07)=$8,435.*TaxonSV=($65,000-$8,435)(0.35)=$19,798.TheprojecthasanNPVof$10,841;thus,itshouldbeaccepted.YearNetCashFlowPV@12%_0—($126,000)―($126,000)42,518 37,96347,579 37,93085,628 60,948 NPV=$10,841Alternatively,placethecashflowsonatimeline:12%|2-126,000 42,51847,579 34,926-126,000 42,51850,70285,628Withafinancial calculator, inputtheappropriatecashflowsintothecashflow register, input I=12,and thensolveforNPV$10,840.51 $10,841.11-9a.Expectedannualcashflows:ProjectA: ProbableProbabilityXCashFlow=CashFlow0.2$6,000$1,2000.66,7504,0500.27,5001,500Expectedannualcashflow=$6,750ProjectB:ProbableProbabilityXCashFlow=CashFlow0.2$0$00.6 6,7504,0500.218,0003,600Expectedannualcashflow=$7,650

ProjectA:A [($750)10.2) ($0)10.6) ($750)(0.2) $474.34.ProjectB:Coefficientofvariation:CVStandard deviationExpectedvalueCoefficientofvariation:CVStandard deviationExpectedvalueNPVExpectedNPV2$7,650) (0.2)2(-2$7,650) (0.2)2(-$900) (0.6)($10,350) (0.2) $5,797.84.CVa=$474.34/$6,750=0.0703.CVb=$5,797.84/$7,650=0.7579.hasthegreatermeasuredby thewhileProjectAhasthegreatermeasuredby thewhileProjectAvariability initsprobablecashflows,whetherstandarddeviationorthecoefficientofvariation.Hence,ProjectBisevaluatedatthe12percentcostofcapital,requiresonlya10percentcostofcapital.Usingafinancialcalculator, inputtheappropriateexpectedannualcashflowsforProjectAintothecashflowregister,inputI=10,andthensolveforNPVa=$10,036.25.Usingafinancialcalculator, inputtheappropriateexpectedannualcashflowsforProjectBintothecashflowregister,inputI=12,andthensolveforNPVb=$11,624.01.Project Bhasthehigher NPV;therefore,thefirmshouldacceptProjectB.c.TheportfolioeffectsfromProjectBwouldtendtomakeitlessriskythanotherwise.ThiswouldtendtoreinforcethedecisiontoacceptProjectB.Again,ifProjectBwerenegativelycorrelatedwiththeGDP(ProjectBisprofitable whentheeconomyis down), then itislessriskyandProjectB'sacceptaneeisreinforced.AnswersandSolutions:11-1111-10Ifactuallifeis5years:0I123410%I I I I+^°% 1Investmentoutlay(36,000)Usingatimelineapproach:Operatingcashflowsexcl.deprec.(AT) 7,2007,2007,2007,2007,200Depreciationsavings 2,8802,8802,8802,8802,880Netcashflow(36,000)10,08010,08010,08010,08010,080NPV10%=$2,211.13.Ifactuallifeis4years:Usingatimelineapproach:0II2I3I^% Investmentoutlay (36,000)Operatingcashflowsexcl.deprec.(AT) 7,2007,2007,2007,200Depreciationsavings 2,8802,8802,8802,880Taxsavingsonloss 88 Netcashflow(36,000)10,08010,08010,08012,960NPV10%=-$2,080.68.Ifactuallifeis8years:Usingatimelineapproach:IIInvestmentoutlay(36,000)Operatingcashflowsexcl.deprec.(AT)7,200 7,2007,2007,2007,200Depreciationsavings2,8802,880 Netcashflow(36,000)10,080 10,0807,2007,2007,200NPV10%=$13,328.93.Ifthelifeisaslowas4years(anunlikelyevent),willnotbedesirable. But,ifthe investment lifeisyears,theinvestmentwillbeagoodone.Therefore,thedecisionwilldependonthedirectors'confidenceinthelifeofthetractor.Giventhelowproba-bility ofthetractor's lifebeingonlylikelythatthedirectorswilldecidetopurchasethetractor.the investmentlonger than 44years,itisSPREADSHEETPROBLEMbothonSouthbothonSouth-theinstructor'sresourceCD-ROMandontheinstructor'ssideofWestern'swebsite,.INTEGRATEDCASEAlliedFoodProductsCapitalBudgetingandCashFlowEstimation11-12AFTERSEEINGSNAPPLESSUCCESSWITHNONCOLASOFTDRINKSANDLEARNING11-12OFCOKESANDPEPSI'SINTEREST,ALLIEDFOODPRODUCTSHASDECIDEDTOCONSIDERANEXPANSIONOFITSOWNINTHEFRUITJUICEBUSINESS.THEPRODUCTBEINGCONSIDEREDISFRESHLEMONJUICE.ASSUMETHATYOUWERERECENTLYHIREDASASSISTANTTOTHEDIRECTOROFCAPITALBUDGETING,ANDYOUMUSTEVALUATETHENEWPROJECT.THELEMONJUICEWOULDBEPRODUCEDINANUNUSEDBUILDINGADJACENTTOALLIED'SFORTMYERSPLANT;ALLIEDOWNSTHEBUILDING,WHICHISFULLYDEPRECIATED.THEREQUIREDEQUIPMENTWOULDCOST$200,000,PLUSANADDITIONAL$40,000FORSHIPPINGANDINSTALLATION. INADDITION,INVENTORIESWOULDRISEBY$25,000,WHILEACCOUNTSPAYABLEWOULDGOUPBY$5,000. ALLOFTHESECOSTSWOULDBEINCURREDATt=0.BYASPECIALRULING,THEMACHINERYCOULDBEDEPRECIATEDUNDERTHEMACRSSYSTEM AS3-YEARPROPERTY.THEAPPLICABLEDEPRECIATIONRATESARE33PERCENT,3-YEARPROPERTY.THEAPPLICABLEDEPRECIATIONRATESARE33PERCENT,45PERCENT,15PERCENT,AND7PERCENT.THEPROJECTISEXPECTEDTOOPERATEFOR4YEARS,ATWHICHTIMEITWILLBETERMINATED.THECASHINFLOWSAREASSUMEDTOBEGIN1YEARAFTERTHEPROJECTISUNDERTAKEN,ORATt=1,ANDTOCONTINUEOUTTOt=4.ATTHEENDOFTHEPROJECTSLIFE(t=4),THEEQUIPMENTISEXPECTEDTOHAVEASALVAGEVALUEOF$25,000.UNITSALESAREEXPECTEDTOTOTAL100,000CANSPERYEAR,ANDTHEEXPECTEDSALESPRICEIS$2.00PERCAN.CASHOPERATINGCOSTSFORTHEPROJECT(TOTALOPERATINGCOSTSLESSDEPRECIATION)AREEXPECTEDTOTOTAL60PERCENTOFDOLLARSALES.ALLIED'STAXRATEIS40PERCENT,ANDITSWEIGHTEDAVERAGECOSTOFCAPITALIS10PERCENT.TENTATIVELY,THELEMONJUICEPROJECTISASSUMEDTOBEOFEQUALRISKTOALLIED'SOTHERASSETS.YOUHAVEBEENASKEDTOEVALUATETHEPROJECTANDTOMAKEA

RECOMMENDATIONASTOWHETHERITSHOULDBEACCEPTEDORREJECTED.TO

GUIDEYOUINYOURANALYSIS,YOURBOSSGAVEYOUTHEFOLLOWINGSETOFQUESTIONS.TABLEIC11-1.ALLIED'SLEMONJUICEPROJECT(TOTALCOSTINTHOUSANDS)ENDOFYEAR:0 1 2 ENDOFYEAR:0 1 2 3 4 I.INVESTMENTOUTLAYI.INVESTMENTOUTLAYEQUIPMENTCOSTINSTALLATIONINCREASEININVENTORYINCREASEINACCOUNTSPAYABLETOTALNETINVESTMENTII.OPERATINGCASHFLOWSII.OPERATINGCASHFLOWSUNITSALES(THOUSANDS) 100PRICE/UNIT $2.00$2.00TOTALREVENUES $200.0OPERATINGCOSTS,EXCLUDINGDEPRECIATION$120.0UNITSALES(THOUSANDS) 100PRICE/UNIT $2.00$2.00TOTALREVENUES $200.0OPERATINGCOSTS,EXCLUDINGDEPRECIATION$120.0DEPRECIATION 36.0TOTALCOSTS $199.2$228.0OPERATINGINCOMEBEFORETAXES16.8 $44.0III.IV.V.TAXESONOPERATINGINCOMEOPERATINGINCOMEAFTERTAXESDEPRECIATION 79.20.336.0OPERATINGCASHFLOW$0.0$79.725.3$26.4$54.7III.IV.V.TAXESONOPERATINGINCOMEOPERATINGINCOMEAFTERTAXESDEPRECIATION 79.20.336.0OPERATINGCASHFLOW$0.0$79.725.3$26.4$54.7TERMINALYEARCASHFLOWSRETURNOFNETOPERATINGWORKINGCAPITALSALVAGEVALUETAXONSALVAGEVALUETOTALTERMINATIONCASHFLOWSNETCASHFLOWSNETCASHFLOW ($260.0) $89/RESULTSNPV=IRR=MIRR=PAYBACK=A.DRAWATIMELINETHATSHOWSWHENTHENETCASHINFLOWSANDOUTFLOWSA.WILLOCCUR,ANDEXPLAINHOWTHETIMELINECANBEUSEDTOHELPSTRUCTURETHEANALYSIS.ANSWER: [SHOWS11-1THROUGHS11-4HERE.]0 1 2 3 4|—|——|——|——| CFo CF1 CF2 CF3 CF4TIMELINESAREHELPFULFORSHOWINGWHERECASHFLOWSOCCUR.WHENTHEDATAAREDEVELOPED,ANDNUMBERSHAVEBEENPUTONTHETIMELINE,ITFACILITATESINPUTTINGTHECASHFLOWSINTOACALCULATORTOCALCULATETHENPV,IRR,MIRR,ANDPAYBACK.B. ALLIEDHASASTANDARDFORMTHATISUSEDINTHECAPITALBUDGETINGPROCESS;SEETABLEIC11-1.PARTOFTHETABLEHASBEENCOMPLETED,BUTYOUMUSTREPLACETHEBLANKSWITHTHEMISSINGNUMBERS. COMPLETETHETABLEINTHEFOLLOWINGSTEPS:1.FILLINTHEBLANKSUNDERYEAR0FORTHEINITIALINVESTMENTOUTLAY.ANSWER: [SHOWS11-5HERE.]THISANSWERISSTRAIGHTFORWARD.NOTETHATACCOUNTSPAYABLEISANOFFSETTOTHEINVENTORYBUILDUP,SOTHENETOPERATINGWORKINGCAPITALREQUIREMENTIS$20,000,WHICHWILLBERECOVEREDATTHEENDOFTHEPROJECTSLIFE.[SEECOMPLETEDTABLEINTHEANSWERTOB5.]B.2.COMPLETETHETABLEFORUNITSALES,SALESPRICE,TOTALREVENUES,ANDOPERATINGCOSTSEXCLUDINGDEPRECIATION.ANSWER: THISANSWERREQUIRESNOEXPLANATION.STUDENTSMAYNOTE,THOUGH,THATINFLATIONISNOTREFLECTEDATTHISPOINT.ITWILLBELATER.[THECOMPLETEDTABLEISSHOWNBELOWINTHEANSWERTOB5.]B.3.COMPLETETHEDEPRECIATIONDATA.ANSWER: [SHOWS11-6HERE.]THEONLYTHINGTHATREQUIRESEXPLANATIONHEREISTHEUSEOFTHEDEPRECIATIONTABLESINTHEWEBAPPENDIX11A.HEREARETHERATESFOR3-YEARPROPERTY;THEYAREMULTIPLIEDBYTHEDEPRECIABLEBASIS,$240,000,TOGETTHEANNUALDEPRECIATIONALLOWANCES:(DOLLARSINTHOUSANDS)YEAR10.33$240$79.2YEAR20.45$240108.0YEAR30.15$24036.0YEAR40.07$24016.81.00 $240.0B.4.NOWCOMPLETETHETABLEDOWNTOOPERATINGINCOMEAFTERTAXES,ANDTHENDOWNTONETCASHFLOWS.ANSWER: [SHOWS11-7HERE.]THISISSTRAIGHTFORWARD.THEONLYEVENSLIGHTLYCOMPLICATEDTHINGISADDINGBACKDEPRECIATIONTOGETNETCF.[THECOMPLETEDTABLEISSHOWNBELOWINTHEANSWERTOB5.]B.5.NOWFILLINTHEBLANKSUNDERYEAR4FORTHETERMINALCASHFLOWS,ANDCOMPLETETHENETCASHFLOWLINE.DISCUSSNETOPERATINGWORKINGCAPITAL.WHATWOULDHAVEHAPPENEDIFTHEMACHINERYWERESOLDFORLESSTHANITSBOOKVALUE?ANSWER: [SHOWS11-8HERE.]THESEAREALLSTRAIGHTFORWARD.NOTETHATTHENET OPERATINGWORKINGCAPITALREQUIREMENTISRECOVEREDATTHEENDOFYEAR4.ALSO,THESALVAGEVALUEISFULLYTAXABLE,BECAUSETHEASSETHASBEENDEPRECIATEDTOAZEROBOOKVALUE.IFBOOKVALUEWERESOMETHINGOTHERTHANZERO,THETAXEFFECTCOULDBEPOSITIVE(IFTHEASSETWERESOLDFORLESSTHANBOOKVALUE)ORNEGATIVE.I.II.III.IV.TABLEIC11-1.ALLIED'SLEMONJUICEPROJECT

(TOTALCOSTINTHOUSANDS)INPUTS:PRICE:$2.00k:10.0%INFL:0.0%VCRATE:60.0%T-RATE:40%ENDOFYEAR: 0 1 2 3 4INVESTMENTOUTLAYEQUIPMENTCOST ($200)INSTALLATION (40)INCREASEININVENTORY (25)INCREASEINACCOUNTSPAYABLE5TOTALNETINVESTMENT (260)OPERATINGCASHFLOWSUNITSALES(THOUSANDS) 100 100 100 100PRICE/UNIT $2.00$2.00$2.00$2. TOTALREVENUES $200.0$200.0$200.0$200.0OPERATINGCOSTS,EXCLUDINGDEPRECIATION $120.0$120.0$120.0$120.0DEPRECIATION 79.2108.036.01 TOTALCOSTS $199.2$228.0$156.0$136.8OPERATINGINCOMEBEFORETAXES$0.8($28.0)$44.0$63^TAXESONOPERATINGINCOME 0.3(11.2)17.625.3 OPERATINGINCOMEAFTERTAXES $0.5($16.8)$26.4$3DEPRECIATION 79.2 108.0 36.0 1 OPERATINGCASHFLOW$0.0$79.7$91.2$62.4$54.7TERMINALYEARCASHFLOWSRETURNOFNETOPERATINGWORKINGCAPITAL 20.0SALVAGEVALUE 25.0TAXONSALVAGEVALUE (10.0)TOTALTERMINATIONCASHFLOWS $35.0NETCASHFLOWSNETCASHFLOW ($260.0)$79.7$91.2$62.4$89.7CUMULATIVECASHFLOWFORPAYBACK: (260.0)(180.3)(89.1)(26.7) 63.0COMPOUNDEDINFLOWSFORMIRR: 106.1 110.4 68.6 89.7TERMINALVALUEOFINFLOWS: 374.8V.RESULTSNPV= -$4.0IRR= 9.3%MIRR= 9.6%PAYBACK=3.3YEARSC.1.ALLIEDUSESDEBTINITSCAPITALSTRUCTURE,SOSOMEOFTHEMONEYUSEDC.TOFINANCETHEPROJECTWILLBEDEBT.GIVENTHISFACT,SHOULDTHEPROJECTEDCASHFLOWSBEREVISEDTOSHOWPROJECTEDINTERESTCHARGES?EXPLAIN.ANSWER:[SHOWS11-9HERE.]THEPROJECTEDCASHFLOWSINTHETABLESHOULDNOTBEREVISEDTOSHOWINTERESTCHARGES.THEEFFECTSOFDEBTFINANCINGAREREFLECTEDINTHECOSTOFCAPITAL,WHICHISUSEDTODISCOUNTTHECASHFLOWS.C.2.SUPPOSEYOULEARNEDTHATALLIEDHADSPENT$50,000TORENOVATETHEBUILDINGLASTYEAR,EXPENSINGTHESECOSTS.SHOULDTHISCOSTBEREFLECTEDINTHEANALYSIS?EXPLAIN.ANSWER: [SHOWS11-10HERE.]THISEXPENDITUREISASUNKCOST,HENCEITWOULDNOTAFFECTTHEDECISIONANDSHOULDNOTBEINCLUDEDINTHEANALYSIS.C.3.NOWSUPPOSEYOULEARNEDTHATALLIEDCOULDLEASEITSBUILDINGTOANOTHERPARTYANDEARN$25,000PERYEAR.SHOULDTHATFACTBEREFLECTEDINTHEANALYSIS?IFSO,HOW?ANSWER:[SHOWS11-11 HERE.] THERENTALPAYMENTREPRESENTSANOPPORTUNITYCOST,ANDASSUCHITSAFTER-TAXAMOUNT,$25,000(1-T)=$25,000(0.6)=$15,000,SHOULDBESUBTRACTEDFROMTHECASHFLOWSTHECOMPANYWOULDOTHERWISEHAVE.C.4.NOWASSUMETHATTHELEMONJUICEPROJECTWOULDTAKEAWAYPROFITABLESALESFROMALLIEDSFRESHORANGEJUICEBUSINESS.SHOULDTHATFACT BEREFLECTEDINYOURANALYSIS?IFSO,HOW?ANSWER:[SHOWS11-12HERE.]THEDECREASEDSALESFROMALLIED'SFRESHORANGEJUICEBUSINESSSHOULDBEACCOUNTEDFORINTHEANALYSIS.THISISANEXTERNALITYTOALLIED--THELEMONJUICEPROJECTWILLAFFECTTHECASHFLOWSTOITSORANGEJUICEBUSINESS.SINCETHELEMONJUICEPROJECTWILLTAKEBUSINESSAWAYFROMITSORANGEJUICEBUSINESS,THEREVENUESASSHOWNINTHISANALYSISAREOVERSTATED,ANDTHUSTHEYNEEDTOBE

REDUCEDBYTHEAMOUNTOFDECREASEDREVENUESFORTHEORANGEJUICEBUSINESS.EXTERNALITIESAREOFTENDIFFICULTTOQUANTIFY,BUTTHEYNEEDTOBECONSIDERED.D.ANSWER:DISREGARDALLTHEASSUMPTIONSMADEINPARTC,ANDASSUMETHEREWASNOD.ANSWER:ALTERNATIVEUSEFORTHEBUILDINGOVERTHENEXT4YEARS. NOWCALCULATETHEPROJECTSNPV,IRR,MIRR,ANDREGULARPAYBACK.DOTHESEINDICATORSSUGGESTTHATTHEPROJECTSHOULDBEACCEPTED?LINEANDEXPLAINHOWEACHOFTHEINDICATORSISCALCULATED.WEBASEOUREXPLANATIONONFINANCIALCALCULATORS,BUTITWOULDBEEQUALLYEASYTOEXPLAINUSINGAREGULARCALCULATORANDEITHEREQUATIONSORTABLES.0|(260)10%279.7 91.2 62.489.7NPV=-$4.0.NPVISNEGATIVE;DONOTACCEPT.IRR=$260宜二竺厶上厶(1IRR)(1LINEANDEXPLAINHOWEACHOFTHEINDICATORSISCALCULATED.WEBASEOUREXPLANATIONONFINANCIALCALCULATORS,BUTITWOULDBEEQUALLYEASYTOEXPLAINUSINGAREGULARCALCULATORANDEITHEREQUATIONSORTABLES.0|(260)10%279.7 91.2 62.489.7NPV=-$4.0.NPVISNEGATIVE;DONOTACCEPT.IRR=$260宜二竺厶上厶(1IRR)(1IRR)(1IRR)(1IRR)0.IRR=9.3%.IRRISLESSTHANCOSTOFCAPITAL;DONOTACCEPT.MIRR:0 1 10%2|| (260) 79.7 91.23 4—|