Question

QUESTION 18

1. Questions 18 to 23:

   Celestila Moonn is looking at the capital budgeting analysis for her firm. Her firm, SchoolStreet, is considering in upgrading the firm’s production capacity in an effort to improve the company’s competitive position. Moonnis being assisted by Amy Sun, an UMB MBA intern at SchoolStreet. While evaluating the capital budgeting analysis, Sun gathered the data below:

   • Sun estimates that the new HP-450N2 copy machine will costs $335,000 and an additional $165,000 is needed for shipping and install it. The HP-450N2 will be depreciated straight-line to zero over a five-year life. The HP-450N2 will generate additional annual revenues of $295,000, and it will have annual cash operating expenses of $113,000.
   • SchoolStreet borrowed $200,000 to purchase the equipment. The discount rate for this Capital budgeting is 10%.
   • The firm's inventories would have to be increased by $65,000 to handle the new line; however, its accounts payable would rise by $28,000.
   • The HP-450N2 will be sold for $95,000 after five years
   • The firm's tax rate IS 40%

   Factor -1: Before making the final calculations, Moon and Sun discussed the net present value analysis for the projects SchoolStreet is considering. Moonn tells Sun that we should include any financial flows such as interest expense or dividends paid to the investors who furnished the capital for the project under consideration.

   Factor -2: Moonn was not sure whether Sun’s estimated depreciable lives of 5-year was correct and the straight-line depreciation method is appropriate for this project and was wondering what would have been the impact on NPV had Sun used 7-year depreciable lives and 5-MARCS depreciation schedule instead of 5-year straight-line method?

   Factor -3: Moonn also tells Sun that we should include the revitalization cost of $100,000 in the capital budgeting analysis that SchoolStreet had spent last year to revitalize the production line site.

   Based on her estimates on new HP-450N2 copy machine, what was the initial investment?

   A.

   $537,000

   B.

   $593,000

   C.

   $500,000

2. QUESTION 19: The incremental annual after-tax operating cash flow is closest to:

3. A.

   $149,200

   B.

   $89,200

   C.

   $92,000

4. QUESTION 20: The fifth year’s after-tax non-operating cash flow is closest to:

5. A.

   $150,000

   B.

   $75,500

   C.

   $94,000

6. QUESTION 21: With respect to Moon’s concerns in Factor 1, was Moonn correct to include interest expense in the capital budgeting analysis?

7. 	A.	No, the return required by the investors provided the capital is already accounted for when we applied the 10 % discount rate, as a result, including financing cash flows would be double counted.
   	B.	Yes, if 10% borrowing cost of capital was not included on the analysis, net income and operating cash flows would have been reduced and the income tax would have been higher.
   	C.	Yes, operating cash flow is calculated by adding back all non-cash transactions to net income, which excluded interest expense because interest expense is tax deduct edible. QUESTION 22: With respect to $100,000 revitalization cost, in Factor 3, are Moon and Sun correct? A. Yes, Sun is correct because SchoolStreet had invested $100,000 to revitalize the production line site and it should be included as cash out flow in the analysis. B. No, because the revitalization cost is a sunk cost and it should not be included as cash out flow in the analysis. C. Yes, Moonn is correct.

8. QUESTION 23: Sun calculates followings

9. 	A.	NPV IRR PI Payback $65,723 13.8% 1.13 3.4 years
   	B.	$56,723 13.1% 1.2 3.1 years
   	C.	$86,950 15.72% 1.16 4.0 years

Answer 1

Q 18) Initial investments
Costs to be incurred	$      335,000
shipping costs	$      165,000
Cost of equipmet	$      500,000
Increase in inventory	$         65,000
Less: Increase in accounts payable	$       (28,000)
Initial investments	$      537,000
Correct answer is A) $ 537,000
Q 19) Incremental annual after-tax operating cash flow
Additional revenue generation	$      295,000
Less: Annual cash operating expenses	$     (113,000)
Less: Depreciation on equipment	$     (100,000)	($ 500,000)/5
Profit before Tax	$         82,000
Less: Tax	$       (32,800)	40%* PBT
Profit after Tax	$         49,200
Add:Depreciation	$      100,000
Incremental annual after-tax operating cash flow	$      149,200
Correct answer is A) $ 149,200
Q 20) 5th Year after-tax non-operating cash flow
Release of working capital	$         37,000
Add: Salvage value	$         95,000
Less: Tax on Salvage	$       (38,000)	40%*Salvage value
After tax non operating cash flow	$         94,000
Q 21) With respect to Moon’s concerns in Factor 1
Correct answer is
C) Yes, operating cash flow is calculated by adding back all non-cash transactions to net income, which excluded interest expense because interest expense is tax deduct edible
Q 22) With respect to Moon’s concerns in Factor 3
Correct answer is
B) No, because the revitalization cost is a sunk cost and it should not be included as cash out flow in the analysis.
Q 23)
Calculation of NPV
Initial investments	$      537,000
After tax non operating cash flow	$      149,200
P.V.F @ 10% for 5 Years	3.79
PV of After tax non operating cash flow	$ 565,585.39
5th Year after-tax non-operating cash flow	$         94,000
P.V.F @ 10% at 5th Year	0.62
PV of 5th Year after-tax non-operating cash flow	$   58,366.60
Total PV of Inflows	$ 623,951.99
Initial investments	$ 537,000.00
NPV	$   86,951.99	PV of Inflows- Initial investments
PI	1.16	PV of Inflows/Initial investments
As we can see both NPV & PI agree to the 4th option
So the correct answer is
C)
NPV= $ 86,950, IRR=15.72%, PI=1.16, Payback=4.0 years

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