Question

?(Determining relevant cash? flows)??Landcruisers Plus? (LP) has operated an online retail store selling? off-road truck parts. As the name? implies, the firm specializes in parts for the venerable Toyota FJ40 that is known throughout the world for its durability and offroad prowess. The fact that Toyota stopped building and exporting the FJ40 to the U.S. market in 1982 meant that FJ40 owners depended more and more on? re-manufactured parts to keep their beloved? off-road vehicles running. More and more FJ40 owners are replacing the original inline? six-cylinder engines with a modern? American-built engine. The engine replacement requires mating the new engine with the Toyota drive train. ?LP's owners had been offering engine adaptor kits for some time but have recently decided to begin building their own units. To make the adaptor kits the firm would need to invest in a variety of machine tools costing a total of ?$600,000. ?LP's management estimates that they will be able to borrow ?$360,000 from the? firm's bank and pay 8 percent interest. The remaining funds would have to be supplied by? LP's owners. The firm estimates that they will be able to sell? 1,000 units a year for ?$1,350 each. The units would cost ?$1,000 each in cash expenses to produce? (this does not include depreciation expense of ?$60,000 per year or interest expense of ?$28,800?). After all? expenses, the firm expects earnings before interest and taxes of ?$290,000. The firm pays taxes equal to 31 ?percent, which results in net income of ?$171,300 per year over the 10?-year expected life of the equipment.

a.??What is the annual free cash flow LP should expect to receive from the investment in year 1 assuming that it does not require any other investments in either capital equipment or working capital and the equipment is depreciated over a 10-year life to a zero salvage and book? value? How should the financing cost associated with the ?$360,000 loan be incorporated into the analysis of cash? flow?

b. If the? firm's required rate of return for its investments is 11 percent and the investment has a 10?-year expected? life, what is the anticipated NPV of the?investment?

Answer 1

answera

CALCULATION OF ANNUAL FREE CASHFLOW

		sales(1000 * 1350)	1350000
		less: costs other than dep & int(1000 * 1000)	1000000
		less: dep	60000
		profit before tax	290000
		tax@31%	89900
		profit after tax	201000
		add: dep( note: dep is non cash expense)	60000
		operating cash flow	261000

there are two sides of a project (1) investment side and (2) financing side

cashflow on the investment side will show the initial investment /cash outflow in the project and cash inflows each year..

The financing side will include the finances received to fund the project/cash inflow and the interest and repayments /cash outflow.

while defining the cashflows on the investment side, financing costs should not be considered because they will be reflected in the cost of capital figure against which the rate of return will be evaluated

SO FINANCING COST IS INCLUDED IN COST OF CAPITAL

answer b

NPV = present value of cash inflows - initial investment

= (261000 * Present value annuity factor at 11% for 10 yrs) - 600000

= (261000 * 5.889) - 600000

= 1537029-600000=$937029