Alliance is considering automating their production process to become more efficient. In order to do so they will buy a new monorail manufacturing system at a cost of $500,000. The system will be depreciated using seven-year MACRS (15%, 25%, 17%, 12%, 9%, 9%, 9%, 4%). The system will be sold in five years for $200,000. If they buy the system they will Trade In their current trolleys for $100,000. The trolleys were originally bought four years ago for $500,000 and are being depreciated using straight-line depreciation over five years. If Alliance does not replace the trolleys, they will be kept for the next five years when they will be sold for $10,000. The new system will not affect Alliance’s sales but will reduce Costs of Goods Sold by $1,000,000. However, Fixed Costs will rise by $50,000 per year if the monorail system is installed. The tax rate is 40%. What are the incremental cash flows associated with this proposed project?
Balance Sheet Effects |———-Depreciation Expenses————-|
Today Year 1 Year 2 Year 3 Year 4 Year 5 End
1. Buy New Assets
2. Trade In Old Assets
3. Keep Old Assets
4. Change in NWC
Income Statement Effects
Year 1 Year 2 Year 3 Year 4 Year 5
Net Sales
– Net COGS
– Net Depreciation
– Net Fixed Costs
= Net OEBT
– Net Taxes
= Net OEAT
+ Net Depreciation
= Net Operating CF
Total Cash Flows
CF0 =
C01 =
C02 =
C03 =
C04 =
C05 =
C06 =
1. What is the Initial Cost of this project?
a) $300,000
b) $400,000
c) $500,000
d) $600,000
2. What is net depreciation expense on the income statement in Year 1?
a) -$75,000
b) -$25,000
c) $100,000
d) $175,000
3. What is the After Tax Salvage Value of selling the equipment at the end?
a) $164,000
b) $182,000
c) $218,000
d) $236,000
4. What is the Operating Cash Flow in Year 2
a) $430,000
b) $510,000
c) $560,000
d) $620,000
5. What is the NPV of this project?
a) $500,000
b) $1,000,000
c) $1,500,000
d) $2,000,000
Kaffie Frederick is considering an expansion of it’s operations by introducing a new product line. In order to expand, they will have to buy new machinery for $1,000,000. The machinery will be depreciated using three-year MACRS (33%, 45%, 15%, 7%). In four years they will be able to sell the machinery for $250,000. If they go through with the planned expansion, Sales of the new product will be $750,000 per year and sales of the old product will rise by $50,000 per year. Variable Costs on the new product are 75% of new product sales while variable costs on the old product are 65% of old product sales. The new project will require additional fixed costs of $20,000 per year. The tax rate is 40%. What are the incremental cash flows associated with this proposed project?
Balance Sheet Effects |———-Depreciation Expenses————-|
Today Year 1 Year 2 Year 3 Year 4 Year 5 End
1. Buy New Assets
2. Trade In Old Assets
3. Keep Old Assets
4. Change in NWC
Income Statement Effects
Year 1 Year 2 Year 3 Year 4 Year 5
Net Sales
– Net COGS
– Net Depreciation
– Net Fixed Costs
= Net OEBT
– Net Taxes
= Net OEAT
+ Net Depreciation
= Net Operating CF
Total Cash Flows
CF0 =
C01 =
C02 =
C03 =
C04 =
C05 =
C06 =
6. What is the Initial Cost of this project?
a) $500,000
b) $1,000,000
c) $1,500,000
d) $2,000,000
7. What is net depreciation expense on the income statement in Year 1?
a) $175,000
b) $250,000
c) $330,000
d) $475,000
8. What is the After Tax Salvage Value of selling the equipment at the end?
a) $110,000
b) $150,000
c) $175,000
d) $215,000
9. What is the Operating Cash Flow in Year 2
a) $238,000
b) $291,000
c) $363,000
d) $422,000
10. What is the IRR of this project?
a) 0%
b) 5%
c) 10%
d) 15%
