Question

In: Accounting

Daily Enterprises is purchasing a $ 9.7$9.7 million machine. It will cost $ 45 comma 000$45,000...

Daily Enterprises is purchasing a

$ 9.7$9.7

million machine. It will cost

$ 45 comma 000$45,000

to transport and install the machine. The machine has a depreciable life of five years using​ straight-line depreciation and will have no salvage value. The machine will generate incremental revenues of

$ 4.3$4.3

million per year along with incremental costs of

$ 1.4$1.4

million per year.​ Daily's marginal tax rate is

35 %35%.

You are forecasting incremental free cash flows for Daily Enterprises. What are the incremental free cash flows associated with the new​ machine?

2.

Castle View Games would like to invest in a division to develop software for a​ soon-to-be-released video game console. To evaluate this​ decision, the firm first attempts to project the working capital needs for this operation. Its chief financial officer has developed the following estimates​ (in millions of​ dollars):  ​(To copy the table below and use in​ Excel, click on icon in the upper right corner of​ table.)

Year 1

Year 2

Year 3

Year 4

Year 5

1

Cash

44

1212

1616

1515

1616

2

Accounts receivable

2020

2525

2424

2424

2424

3

Inventory

66

88

1111

1212

1616

4

Accounts payable

1818

2121

2424

2929

3232

Assuming that Castle View currently does not have any working capital invested in this​ division, calculate the cash flows associated with changes in working capital for the first five years of this investment. ​(Note: Enter decreases as negative​ numbers.)

Solutions

Expert Solution

1)

Incremental Free cash flows associated with new machine $2,567,150

Explanation:-

Cost of machine = Purchase cost of machine + transport and Installation cost
Cost of machine = $9,700,000 + $45,000 = $9,745,000
Computation of free cash flows associated with new machine:
Incremental revenue $4,300,000
Less: Incremental cost ($1,400,000)
$2,900,000
Less: Depreciation ($9,745,000/5 years) (1,949,000)
Earnings before tax $951,000
Less: Tax ($951,000 × 35%) ($332,850)
Earnings after tax $618,150
Incremental free cash flows = Earnings after tax + Depreciation
Incremental free cash flows= $618,150 + $1,949,000
Incremental free cash flows = $2,567,150

2)

(In millions of dollar)
Year 1 Year 2 Year 3 Year 4 Year 5
Cash $44 $1,212 $1,616 $1,515 $1,616
Account Receivable $2,020 $2,525 $2,424 $2,424 $2,424
Inventory $66 $88 $1,111 $1,212 $1,616
Total current assets $2,130 $3,825 $5,151 $5,151 $5,656
Less: Account payable ($1,818) ($2,121) ($2,424) ($2,929) ($3,232)
Net working capital (Total current assets - Account Payable) $312 $1,704 $2,727 $2,222 $2,424
Change in Net working capital $312 $1,392 ($1,704 - $312) $1,023 ($2,727- $1,704) ($505) [$2,222--$2,727] $202 ($2,424 -$2,222)

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