Chapter 12 3 Suppose You Sell Fixed Asset For

50.

You are evaluating a product for your company. You estimate the sales price of product to

be $375 per unit and sales volume to be 500 units in year 1; 1,000 units in year 2; and 200

units in year 3. The project has a three-year life. Variable costs amount to $200 per unit

and fixed costs are $100,000 per year. The project requires an initial investment of

$175,000 in assets that will be depreciated straight-line to zero over the three-year project

life. The actual market value of these assets at the end of year 3 is expected to be

$20,000. NWC requirements at the beginning of each year will be approximately 25

percent of the projected sales during the coming year. The tax rate is 34 percent and the

required return on the project is 10 percent. What will the year 2 free cash flow for this

project be?

51.

You are evaluating a product for your company. You estimate the sales price of product to

be $200 per unit and sales volume to be 2,000 units in year 1; 5,000 units in year 2; and

1,000 units in year 3. The project has a three-year life. Variable costs amount to $75 per

unit and fixed costs are $200,000 per year. The project requires an initial investment of

$360,000 in assets that will be depreciated straight-line to zero over the three-year project

life. The actual market value of these assets at the end of year 3 is expected to be

$40,000. NWC requirements at the beginning of each year will be approximately 20

percent of the projected sales during the coming year. The tax rate is 34 percent and the

required return on the project is 13 percent. What will the year 2 free cash flow for this

project be?

52.

You are evaluating a product for your company. You estimate the sales price of product to

be $50 per unit and sales volume to be 50,000 units in year 1; 75,000 units in year 2; and

10,000 units in year 3. The project has a three-year life. Variable costs amount to $15 per

unit and fixed costs are $100,000 per year. The project requires an initial investment of

$275,000 in assets that will be depreciated straight-line to zero over the three-year project

life. The actual market value of these assets at the end of year 3 is expected to be

$25,000. NWC requirements at the beginning of each year will be approximately 10

percent of the projected sales during the coming year. The tax rate is 34 percent and the

required return on the project is 9 percent. What will the year 2 free cash flow for this

project be?

53.

Your company is considering the purchase of a new machine. The original cost of the old

machine was $100,000; it is now five years old, and it has a current market value of

$40,000. The old machine is being depreciated over a 10-year life toward a zero estimated

salvage value on a straight-line basis, resulting in a current book value of $50,000 and an

annual depreciation expense of $10,000. The old machine can be used for six more years

but has no market value after its depreciable life is over. Management is contemplating

the purchase of a new machine whose cost is $80,000 and whose estimated salvage value

is zero. Expected before-tax cash savings from the new machine are $13,000 a year over

its full MACRS depreciable life. Depreciation is computed using MACRS over a five-year

life, and the cost of capital is 10 percent. Assume a 40 percent tax rate. What will the year

1 operating cash flow for this project be?

54.

Your company is considering the purchase of a new machine. The original cost of the old

machine was $75,000; it is now five years old, and it has a current market value of

$35,000. The old machine is being depreciated over a 10-year life toward a zero estimated

salvage value on a straight-line basis, resulting in a current book value of $37,500 and an

annual depreciation expense of $7,500. The old machine can be used for six more years

but has no market value after its depreciable life is over. Management is contemplating

the purchase of a new machine whose cost is $80,000 and whose estimated salvage value

is zero. Expected before-tax cash savings from the new machine are $15,000 a year over

its full MACRS depreciable life. Depreciation is computed using MACRS over a five-year

life, and the cost of capital is 15 percent. Assume a 40 percent tax rate. What will the year

1 operating cash flow for this project be?

55.

Your company is considering the purchase of a new machine. The original cost of the old

machine was $25,000; it is now five years old, and it has a current market value of

$10,000. The old machine is being depreciated over a 10-year life toward a zero estimated

salvage value on a straight-line basis, resulting in a current book value of $12,500 and an

annual depreciation expense of $2,500. The old machine can be used for six more years

but has no market value after its depreciable life is over. Management is contemplating

the purchase of a new machine whose cost is $20,000 and whose estimated salvage value

is zero. Expected before-tax cash savings from the new machine are $3,500 a year over its

full MACRS depreciable life. Depreciation is computed using MACRS over a five-year life,

and the cost of capital is 13 percent. Assume a 40 percent tax rate. What will the year 1

operating cash flow for this project be?

56.

Your company is considering the purchase of a new machine. The original cost of the old

machine was $75,000; it is now five years old, and it has a current market value of

$20,000. The old machine is being depreciated over a 10-year life toward a zero estimated

salvage value on a straight-line basis, resulting in a current book value of $37,500 and an

annual depreciation expense of $7,500. The old machine can be used for six more years

but has no market value after its depreciable life is over. Management is contemplating

the purchase of a new machine whose cost is $60,000 and whose estimated salvage value

is zero. Expected before-tax cash savings from the new machine are $10,000 a year over

its full MACRS depreciable life. Depreciation is computed using MACRS over a five-year

life, and the cost of capital is 9 percent. Assume a 40 percent tax rate. What will the year 1

operating cash flow for this project be?

57.

Suppose you sell a fixed asset for $99,000 when its book value is $129,000. If your

company’s marginal tax rate is 39 percent, what will be the effect on cash flows of this

sale (i.e., what will be the after-tax cash flow of this sale)?

58.

Suppose you sell a fixed asset for $112,000 when its book value is $112,000. If your

company’s marginal tax rate is 39 percent, what will be the effect on cash flows of this

sale (i.e., what will be the after-tax cash flow of this sale)?

59.

Your company is considering a new project that will require $100,000 of new equipment at

the start of the project. The equipment will have a depreciable life of 10 years and will be

depreciated to a book value of $25,000 using straight-line depreciation. The cost of capital

is 11 percent, and the firm’s tax rate is 34 percent. Estimate the present value of the tax

benefits from depreciation.

60.

Your company is considering a new project that will require $250,000 of new equipment at

the start of the project. The equipment will have a depreciable life of eight years and will

be depreciated to a book value of $10,000 using straight-line depreciation. The cost of

capital is 12 percent, and the firm’s tax rate is 34 percent. Estimate the present value of

the tax benefits from depreciation.

61.

Your company is considering a new project that will require $100,000 of new equipment at

the start of the project. The equipment will have a depreciable life of 10 years and will be

depreciated to a book value of $5,000 using straight-line depreciation. The cost of capital

is 14 percent, and the firm’s tax rate is 30 percent. Estimate the present value of the tax

benefits from depreciation.

62.

You are trying to pick the least expensive car for your new delivery service. You have two

choices: the Scion xA, which will cost $15,000 to purchase and which will have OCF of –

$1,600 annually throughout the vehicle’s expected life of four years as a delivery vehicle;

and the Toyota Prius, which will cost $27,000 to purchase and which will have OCF of –

$750 annually throughout that vehicle’s expected six-year life. Both cars will be worthless

at the end of their life. If you intend to replace whichever type of car you choose with the

same thing when its life runs out, again and again out into the foreseeable future, and if

your business has a cost of capital of 10 percent, what is the EAC of the most expensive

car?

63.

You are evaluating two different cookie-baking ovens. The Pillsbury 707 costs $25,000,

has a six-year life, and has an annual OCF (after tax) of -$5,000 per year. The Keebler

CookieMunster costs $40,000, has a seven-year life, and has an annual OCF (after tax) of

-$500 per year. If your discount rate is 10 percent, what is each machine’s EAC?

64.

KADS, Inc., has spent $400,000 on research to develop a new computer game. The firm is

planning to spend $250,000 on a machine to produce the new game. Shipping and

installation costs of the machine will be capitalized and depreciated; they total $50,000.

The machine has an expected life of three years, a $75,000 estimated resale value, and

falls under the MACRS seven-year class life. Revenue from the new game is expected to

be $600,000 per year, with costs of $250,000 per year. The firm has a tax rate of 35

percent, an opportunity cost of capital of 15 percent, and it expects net working capital to

increase by $100,000 at the beginning of the project. What will the year 0 free cash flow

for this project be?

65.

KADS, Inc., has spent $400,000 on research to develop a new computer game. The firm is

planning to spend $150,000 on a machine to produce the new game. Shipping and

installation costs of the machine will be capitalized and depreciated; they total $50,000.

The machine has an expected life of three years, a $75,000 estimated resale value, and

falls under the MACRS seven-year class life. Revenue from the new game is expected to

be $600,000 per year, with costs of $250,000 per year. The firm has a tax rate of 35

percent, an opportunity cost of capital of 15 percent, and it expects net working capital to

increase by $100,000 at the beginning of the project. What will the year 0 free cash flow

for this project be?

66.

KADS, Inc., has spent $400,000 on research to develop a new computer game. The firm is

planning to spend $250,000 on a machine to produce the new game. Shipping and

installation costs of the machine will be capitalized and depreciated; they total $50,000.

The machine has an expected life of three years, a $75,000 estimated resale value, and

falls under the MACRS seven-year class life. Revenue from the new game is expected to

be $500,000 per year, with costs of $200,000 per year. The firm has a tax rate of 35

percent, an opportunity cost of capital of 15 percent, and it expects net working capital to

increase by $100,000 at the beginning of the project. What will the year 1 free cash flow

for this project be?

67.

KADS, Inc., has spent $400,000 on research to develop a new computer game. The firm is

planning to spend $50,000 on a machine to produce the new game. Shipping and

installation costs of the machine will be capitalized and depreciated; they total $50,000.

The machine has an expected life of three years, a $75,000 estimated resale value, and

falls under the MACRS five-year class life. Revenue from the new game is expected to be

$500,000 per year, with costs of $200,000 per year. The firm has a tax rate of 35 percent,

an opportunity cost of capital of 15 percent, and it expects net working capital to increase

by $100,000 at the beginning of the project. What will the year 2 free cash flow for this

project be?

68.

KADS, Inc., has spent $400,000 on research to develop a new computer game. The firm is

planning to spend $50,000 on a machine to produce the new game. Shipping and

installation costs of the machine will be capitalized and depreciated; they total $50,000.

The machine has an expected life of three years, a $10,000 estimated resale value, and

falls under the MACRS five-year class life. Revenue from the new game is expected to be

$500,000 per year, with costs of $200,000 per year. The firm has a tax rate of 35 percent,

an opportunity cost of capital of 15 percent, and it expects net working capital to increase

by $25,000 at the beginning of the project. What will the year 3 free cash flow for this

project be?

69.

KADS, Inc., has spent $400,000 on research to develop a new computer game. The firm is

planning to spend $50,000 on a machine to produce the new game. Shipping and

installation costs of the machine will be capitalized and depreciated; they total $50,000.

The machine has an expected life of three years, a $15,000 estimated resale value, and

falls under the MACRS five-year class life. Revenue from the new game is expected to be

$500,000 per year, with costs of $300,000 per year. The firm has a tax rate of 35 percent,

an opportunity cost of capital of 15 percent, and it expects net working capital to increase

by $55,000 at the beginning of the project. What will the year 3 free cash flow for this

project be?

70.

Your firm needs a computerized machine tool lathe that costs $50,000, requires $10,000 in

installation, and another $12,000 in maintenance for each year of its three-year life. After

three years, this machine will be replaced. The machine falls into the MACRS three-year

class life category. Assume a tax rate of 30 percent and a discount rate of 12 percent.

Calculate the depreciation tax shield for this project in year 1.