Question

Q1. Florida Enterprises, Inc. is considering a new project whose data are shown below. The equipment that will be used has a 3-year class life and will be depreciated by the MACRS depreciation system. Revenues and Cash operating costs are expected to be constant over the project's 10-year life. What is the Year 1 after-tax net operating cash flow?

Equipment cost (depreciable basis)					$75,000
Sales revenues, each year					$70,000
Cash operating costs					$29,000
Tax rate					20.0%

Q2. Thomson Media is considering investing in some new equipment whose data are shown below. The equipment has a 3-year class life and will be depreciated by the MACRS depreciation system, and it will have a positive pre-tax salvage value at the end of Year 3, when the project will be closed down. Also, some new working capital will be required, but it will be recovered at the end of the project's life. Revenues and cash operating costs are expected to be constant over the project's 3-year life. What is the project's NPV?

WACC											14.0%
	Net investment in fixed assets (depreciable basis)											$60,000
	Required new working capital											$10,000
	Sales revenues, each year											$75,000
	Operating costs excl. depr'n, each year											$30,000
	Expected pretax salvage value											$7,000
	Tax rate											35.0%

Answer 1

1

Time line			1
Sales			70000
Profits	Sales-variable cost		70000
Operating cost			-29000
-Depreciation	Cost of equipment/no. of years		-7500
=Pretax cash flows			33500
-taxes	=(Pretax cash flows)*(1-tax)		26800
+Depreciation			7500
=after tax operating cash flow			34300

2

Time line		0	1	2	3
Cost of new machine		-60000
Initial working capital		-10000
=Initial Investment outlay		-70000
3 years MACR rate			33.33%	44.45%	14.81%	7.41%
Sales			75000	75000	75000
Profits	Sales-variable cost		75000	75000	75000
Operating cost			-30000	-30000	-30000
-Depreciation	=Cost of machine*MACR%		-19998	-26670	-8886	4446	=Salvage Value
=Pretax cash flows			25002	18330	36114
-taxes	=(Pretax cash flows)*(1-tax)		16251.3	11914.5	23474.1
+Depreciation			19998	26670	8886
=after tax operating cash flow			36249.3	38584.5	32360.1
reversal of working capital					10000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				4550
+Tax shield on salvage book value	=Salvage value * tax rate				1556.1
=Terminal year after tax cash flows					16106.1
Total Cash flow for the period		-70000	36249.3	38584.5	48466.2
Discount factor=	(1+discount rate)^corresponding period	1	1.14	1.2996	1.481544
Discounted CF=	Cashflow/discount factor	-70000	31797.63158	29689.5199	32713.3045
NPV=	Sum of discounted CF=	24200.46