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240 Zutter/Smart • Principles of Managerial Finance Brief, Eighth Edition
b. and c. (40% tax rate)
Year = (1) (2) (3) (4) (5) (6)
Old Machine
Revenue - Operating Expenses 14,000$ 16,000$ 20,000$ 18,000$ 14,000$ -$
Less: Taxes (40%) (3,200)$ (4,000)$ (7,000)$ (7,200)$ (5,600)$ -$
New Machine
Revenue - Operating Expenses 30,000$ 30,000$ 30,000$ 30,000$ 30,000$ -$
Less: Depreciation (16,000)$ (25,600)$ (15,200)$ (9,600)$ (9,600)$ (4,000)$
Incremental Cash Flow
(New - Old) = 13,600$ 16,240$ 11,080$ 11,040$ 13,440$ 1,600$
5601234
Cash Flows (40% Tax Rate)
-$41,200 $13,600 $16,240 $11,080 $11,040 $13,440 $1,600
b. and c. (21% tax rate)
Year = (1) (2) (3) (4) (5) (6)
(New - Old) = 14,740$ 15,176$ 10,567$ 11,496$ 14,656$ 840$
Chapter 11 Capital Budgeting Cash Flows and Risk Refinements 241
012
Cash Flows (21% Tax Rate)
-$33,505 $14,740 $15,176 $10,567 $11,496 $14,656 $840
3456
d. If the new machine is eligible for 100% bonus depreciation, then there would be a larger tax benefit
initially (the entire cost would be depreciated right away, reducing taxes) and there would be a higher tax
liability in subsequent years (because depreciation deductions would be zero after the initial cost is fully
expensed).
P11-17 Integrative: Determining relevant cash flows (LG 3, 4, 5, 6; Challenge)
a. Initial investment:
Installed cost of new asset =
Cost of new asset $105,000
−
(0.20
+
0.32)]
×
$60,000
=
$28,800. So, $70,000
−
$28,800
=
$41,200 gain on
asset sale. The tax consequences are: $31,200 recaptured depreciation
×
0.40
=
$12,480 plus $10,000 capital
gain
×
0.40
=.
$4,000. Hence, the total tax of sale of asset
=
$16,480.
b.
Calculation of Operating Cash Flows
Profits before
Depreciation
Net Profits
Net Profits
Operating
Cash
2 24,000 7,200 16,800 6,720 10,080 17,280
3 22,000 7,200 14,800 5,920 8,880 16,080
4 20,000 3,000 17,000 6,800 10,200 13,200
5 18,000 0 18,000 7,200 10,800 10,800
6 0 0 0 0 0 0
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After-tax proceeds from sale of new asset =
Proceeds from sale of new asset $29,000
−Tax on sale of new asset* (9,400)
Total proceeds from sale of new asset 19,600
−After-tax proceeds from sale of old asset =
P11-18 Recognizing risk (LG 1; Basic)
a. and b.
Project Risk Reason
A Low The cash flows from the project can be easily determined because this
244 Zutter/Smart • Principles of Managerial Finance Brief, Eighth Edition
generate a positive NPV (obtained by summing probabilities for ranges above the breakeven
range) is 30% for the standard plant but 45% for the custom plant.
e. A firm wishing to minimize the likelihood of negative NPV should opt for the standard plant
because of the lower cumulative probability cash flows will fall below the breakeven level (10%
P11-20 Basic scenario analysis (LG 2; Basic)
a. and b.
Project Life (Years) = 15
Cost of Capital = 9.30%
PROJECT A PROJECT B
Initial Investment
(Both Projects) = (12,200)$
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P11-22 Personal Finance: Impact of inflation on investments (LG 2; Easy)
a. − c.
Investment
Current
Higher
Inflation
Lower
Inflation
P11-23 Simulation (LG 2; Intermediate)
a. Ogden Corporation could use a computer simulation to generate the probability distribution for
P11-24 Risk-adjusted discount rates: Basic (LG 4; Intermediate)
a.
15%
Year Cash Flows Discounted Cash Flows Discounted Cash Flows Discounted
Project E Project F Project G
Cost of Capital (All Projects) =
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P11-25 Risk-adjusted discount rates—Tabular (LG 4; Intermediate)
a.
Project A
Project B
P11-26 Personal Finance: Mutually exclusive investment and risk (LG 4; Intermediate)
a. Number of years = 6, cost of capital = 8.5%, annual cash inflows = $3,000;
upfront project cost = $10,000.
NPV = Present value of cash inflows – Upfront project cost
Solve for PV = 13,660.76
NPV = $13,660.76 − $10,000 = $3,660.76
b. Number of years = 6, cost of capital = 10.5%, annual cash inflows = $3,800;
upfront project cost = $12,000
Solve for PV = $16,310.28
NPV = $16,310.28 − $12,000 = $4,310.28
c. Using NPV as her guide, Lara should select the second investment with the higher NPV.
d. The second investment is riskier. The higher required return implies a higher risk factor.
Chapter 11 Capital Budgeting Cash Flows and Risk Refinements 249
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License
Cash flows: project cost (CF0) = −$200,000, CF1 = $250,000, CF2 = $100,000, CF3 = $80,000,
CF4 = $60,000, CF5 = $40,000; and cost of capital = 12%.
Solve for NPV = $220,704.25
Manufacture
Cash flows: project cost (CF0) = −$450,000, CF1 = $200,000, CF2 = $250,000, CF3 = $200,000,
CF4 = $200,000, CF5 = $200,000, CF6 = $200,000.
Cost of capital = 12%. Solve for NPV = $412,141.16
Rank Alternative
1 Manufacture
2 License
3 Sell
b. Sell
Number of years= 2, cost of capital = 12%, PV = $177,869.90
Solve for ANPV (annual payment equivalent project NPV) = $105,245.28
P11-31 NPV and ANPV decisions (LG 5; Challenge)
a. – b. Unequal-Life Decisions
Annualized Net Present Value (ANPV)
Samsung Sony
© 2019 Pearson Education, Inc.
P11-32 Real options and the strategic NPV (LG 6; Intermediate)
a. Value of real options = value of abandonment + value of expansion + value of delay
Value of real options = (0.25 × $1,200) + (0.30 × $3,000) + (0.10 × $10,000)
P11-33 Capital rationing—IRR and NPV approaches (LG 6; Intermediate)
a. Rank by IRR
Project IRR Initial Investment Total Investment
F 23% $2,500,000 $2,500,000
E 22 800,000 3,300,000
A 400,000 5,000,000
C 300,000 2,000,000
B 300,000 800,000
D 100,000 1,500,000
G 100,000 1,200,000
© 2019 Pearson Education, Inc.
P11-34 Capital Rationing: NPV Approach (LG 6; Intermediate)
a. Project Initial investment NPV at 13% PV
A $300,000 $ 84,000 $384,000
B 200,000 10,000 210,000
P11-35 Ethics problem (LG 4; Challenge)
Student answers will vary. Some students might argue that companies should be held accountable for any and
a. 1. Plan X
Cash flows: CF0 (project cost) = −$2,700,000, CF1 = $470,000, CF2 = $610,000,
CF3 = $950,000, CF4 = $970,000, and CF5 = $1,500,000.
