# 978-0073382395 Chapter 10 Questions and Problems 1-15

Document Type

Homework Help

Book Title

Fundamentals of Corporate Finance Standard Edition 9th Edition

Authors

Stephen Ross

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B-178 SOLUTIONS

from the sale of new books. Thus, it is important to examine whether the new book would displace sales

of used books (good from the publisher’s perspective) or new books (not good). The concern arises any

time there is an active market for used product.

8. Definitely. The damage to Porsche’s reputation is definitely a factor the company needed to consider. If

the reputation was damaged, the company would have lost sales of its existing car lines.

9. One company may be able to produce at lower incremental cost or market better. Also, of course, one of

the two may have made a mistake!

10. Porsche would recognize that the outsized profits would dwindle as more product comes to market and

competition becomes more intense.

Solutions to Questions and Problems

NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple steps.

Due to space and readability constraints, when these intermediate steps are included in this solutions

manual, rounding may appear to have occurred. However, the final answer for each problem is found

without rounding during any step in the problem.

Basic

1. The $6 million acquisition cost of the land six years ago is a sunk cost. The $6.4 million current aftertax

value of the land is an opportunity cost if the land is used rather than sold off. The $14.2 million cash

outlay and $890,000 grading expenses are the initial fixed asset investments needed to get the project

2. Sales due solely to the new product line are:

19,000($13,000) = $247,000,000

Increased sales of the motor home line occur because of the new product line introduction; thus:

4,500($53,000) = $238,500,000

CHAPTER 10 B-179

3. We need to construct a basic income statement. The income statement is:

Sales $ 830,000

Variable costs 498,000

Fixed costs 181,000

4. To find the OCF, we need to complete the income statement as follows:

Sales $ 824,500

Costs 538,900

Depreciation 126,500

EBT $ 159,100

Net income $ 105,006

The OCF for the company is:

OCF = EBIT + Depreciation – Taxes

5. To calculate the OCF, we first need to calculate net income. The income statement is:

Sales $ 108,000

Variable costs 51,000

Depreciation 6,800

EBT $ 50,200

[email protected]% 17,570

Net income $ 32,630

Using the most common financial calculation for OCF, we get:

OCF = EBIT + Depreciation – Taxes

OCF = $50,200 + 6,800 – 17,570

OCF = $39,430

B-180 SOLUTIONS

6. The MACRS depreciation schedule is shown in Table 10.7. The ending book value for any year is the

beginning book value minus the depreciation for the year. Remember, to find the amount of

depreciation for any year, you multiply the purchase price of the asset times the MACRS percentage for

the year. The depreciation schedule for this asset is:

Year Beginning Book Value MACRS Depreciation Ending Book value

1 $1,080,000.00 0.1429 $154,332.00 $925,668.00

2 925,668.00 0.2449 264,492.00 661,176.00

3 661,176.00 0.1749 188,892.00 472,284.00

7. The asset has an 8 year useful life and we want to find the BV of the asset after 5 years. With straight-

line depreciation, the depreciation each year will be:

Annual depreciation = $548,000 / 8

Annual depreciation = $68,500

So, after five years, the accumulated depreciation will be:

Accumulated depreciation = 5($68,500)

Accumulated depreciation = $342,500

CHAPTER 10 B-181

8. To find the BV at the end of four years, we need to find the accumulated depreciation for the first four

years. We could calculate a table as in Problem 6, but an easier way is to add the MACRS depreciation

amounts for each of the first four years and multiply this percentage times the cost of the asset. We can

then subtract this from the asset cost. Doing so, we get:

BV4 = $7,900,000 – 7,900,000(0.2000 + 0.3200 + 0.1920 + 0.1152)

BV4 = $1,365,120

9. Using the tax shield approach to calculating OCF (Remember the approach is irrelevant; the final

answer will be the same no matter which of the four methods you use.), we get:

OCF = (Sales – Costs)(1 – tC) + tCDepreciation

10. Since we have the OCF, we can find the NPV as the initial cash outlay plus the PV of the OCFs, which

are an annuity, so the NPV is:

B-182 SOLUTIONS

11. The cash outflow at the beginning of the project will increase because of the spending on NWC. At the

end of the project, the company will recover the NWC, so it will be a cash inflow. The sale of the

equipment will result in a cash inflow, but we also must account for the taxes which will be paid on this

sale. So, the cash flows for each year of the project will be:

Year Cash Flow

0 –$4,200,000 = –$3,900,000 – 300,000

1 1,631,500

12. First we will calculate the annual depreciation for the equipment necessary for the project. The

depreciation amount each year will be:

Year 1 depreciation = $3,900,000(0.3333) = $1,299,870

Year 2 depreciation = $3,900,000(0.4445) = $1,733,550

Year 3 depreciation = $3,900,000(0.1481) = $577,590

So, the book value of the equipment at the end of three years, which will be the initial investment minus

the accumulated depreciation, is:

Book value in 3 years = $3,900,000 – ($1,299,870 + 1,733,550 + 577,590)

Book value in 3 years = $288,990

The asset is sold at a loss to book value, so this loss is taxable deductible.

Aftertax salvage value = $210,000 + ($288,990 – 210,000)(0.35)

Aftertax salvage value = $237,647

CHAPTER 10 B-183

13. First we will calculate the annual depreciation of the new equipment. It will be:

Annual depreciation = $560,000/5

Annual depreciation = $112,000

Now, we calculate the aftertax salvage value. The aftertax salvage value is the market price minus (or

plus) the taxes on the sale of the equipment, so:

Aftertax salvage value = MV + (BV – MV)tc

Very often the book value of the equipment is zero as it is in this case. If the book value is zero, the

equation for the aftertax salvage value becomes:

Aftertax salvage value = MV + (0 – MV)tc

Aftertax salvage value = MV(1 – tc)

14. First we will calculate the annual depreciation of the new equipment. It will be:

Annual depreciation charge = $720,000/5

Annual depreciation charge = $144,000

The aftertax salvage value of the equipment is:

Aftertax salvage value = $75,000(1 – 0.35)

Aftertax salvage value = $48,750

Using the tax shield approach, the OCF is:

15. To evaluate the project with a $300,000 cost savings, we need the OCF to compute the NPV. Using the

tax shield approach, the OCF is:

OCF = $300,000(1 – 0.35) + 0.35($144,000) = $245,400

NPV = –$720,000 + 110,000 + $245,400(PVIFA20%,5) + [($48,750 – 110,000) / (1.20)5]

NPV = $99,281.22

The NPV with a $240,000 cost savings is:

OCF = $240,000(1 – 0.35) + 0.35($144,000)

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