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6. The effect of accounts receivables, accounts payables, overhead, and financial costs on
the investment decision.
a.
The new product would increase both accounts receivable and accounts payable. Annual sales of $12
million spread evenly over the year would mean $32,877 per day ($12 million/365 days). If the collection
period on average were 50 days, this would mean an extra investment (an increase in the firm’s accounts
receivable) of $1,643,836 ($32,877 50). For simplicity, let us assume that this would take place at time
0. The firm should expect to get some financing from its suppliers. Annual purchases of $4 million of raw
Using a spreadsheet
A B C D E F G
1Now
Year-end
1
Year-end
2
Year-end
3
Year-end
4
Year-end
5
2
1
0
11 The values in rows 3 and 4 are explained in the text.
1
2The value in cell B7 is data.
1
3The formula in cell B5 is: =B3-B4. Then copy formula in cell B5 to cells C5, D5, E5, F5, and G5.
1
4The formula in cell B9 is: -B5 - NPV(B7,C5:G5).
1
5
b.
The standard charge of one percent of revenues needs a careful look. While it is reasonable to expect
some impact on general overheads from the addition of a new product, an incremental cost amounting to
8-1
Using a spreadsheet
A B C D E F G
1Now
Year-end
1
Year-end
2
Year-end
3
Year-end
4
Year-end
5
2
4
6
Reduction in net present
8
c.
The financing charge of 10 percent levied against the book value of assets used in the project is a fired
7. The effect of depreciation for tax purposes.
Using a spreadsheet
A move imposed by the tax authorities from MACRS to the straight-line method of depreciation will
Note that the change would be a zero-sum game: the loss for the corporation would be a gain for the
government.
A B C D E F G H
1Now
Year-end
1
Year-end
2
Year-end
3
Year-end
4
Year-end
5
Year-end
6
2
8-2
0
11
1
3
1
4II. Under straight-line system
1
1
7
1
9
2
0The values in rows 3, 5, 7, and10 are data
2
1The formula in cell C6 is: =C5*$B$3. Then copy formula in cell C6 to cells D6, E6, F6, G6, and H6.
2
2The formula in cell C8 is: =C6*C7. Then copy formula in cell C8 to cells D8, E8, F8, G8, and H8.
2
3The formula in cell C12 is: =NPV(B10,C8:H8).
2
4The formula in cells C15 to H15 is: =SLN($B$3,0,6), where 6 is the depreciation life.
The formula in cell C16 is: =C15*C7. Then copy formula in cell C16 to cells D16, E16, F16, G16, and H16.
2
5The formula in cell C18 is: =NPV(B10,C16:H16).
26
8. The effect of cannibalization.
These three items must each be handled differently. The $500,000 market study is a sunk cost. It has
The charge for the use of the company’s unoccupied building represents an opportunity cost. It apparently
could be rented for $100,000 per year. There is no information, but it is conceivable that the building
could be rented for more at a later date, or otherwise used by the company more profitably. On the other
The possible ficannibalization” of existing product sales if the new project is taken appears to be a major
8-3
source of uncertainty. This often happens and is difficult to estimate. If we take the CEO’s fiworst-case”
scenario, the present value of the cash-flow impact from lost sales on existing products would be as much
Using a spreadsheet
A B C D E F G
1Now
Year-end
1
Year-end
2
Year-end
3
Year-end
4
Year-end
5
2
1
2
9. Break-even analysis.
Using a spreadsheet
A B C D E F G
1Now
Year-end
1
Year-end
2
Year-end
3
Year-end
4
Year-end
5
2I. Base case
8-4
2
1
1
7
1
1
9
2
0The values in rows 3, 4, 5, 7, 9, 12, and 16 are data.
2
1The formula in row C6 is: =C4*C5. Then copy formula in cell C6 to cells D6, E6, F6, and G6.
2
2The formula in cell C8 is: =C7*C4. Then copy formula in cell C8 to cells D8, E8, F8, and G8.
2
3The formula in cells C10 to G10 is: =SLN(-$B$3,0,5), where 5 is the depreciation life.
2
4The formula in cell C11 is: =C6-C8-C9-C10. Then copy formula in cell C11 to cells D11, E11, F11, and G11.
2
5The formula in cell C13 is: =C11*(1-C12). Then copy formula in cell C13 to cells D13, E13, F13, and G13.
2
6The formula in cell B14 is: =B3+B13+B10. Then copy formula in cell B14 to cells C14, D14, E14, F14, and G14.
2
7The formula in cell C18 is: =B14 + NPV(B16,C14:G14).
2
8
29 II. Break- even analysis
30
Number of snowmobiles
sold per year 50 60 70 80 90 100
32
33 The values in cells B31 to G31 are net present values obtained by changing the number in row 4 to those in row 30.
34 The graph function in the spreadsheet menu is used to obtain the graph below.
8-5
Net present value
a.
The spreadsheet analysis indicates that the project should be undertaken for the expected sale of 100
b.
The graph shows that the break-even sales level, which is the number of snowmobiles to sell every year
The exact break-even sales could also be obtained from the following relationships:
but
Operating profit after tax = [Revenues – Variable costs – Fixed costs – Depreciation expenses] × (1 – Tax rate)
so that
Depreciation expenses
Let Q be the number of snowmobiles sold per year. Then:
or
From the data, in thousands of dollars:
8-6
Number of units
Replacing the variables in the above equation by their values, we get:
or
At the break-even point we have:
from which we get
The present value of an annuity of $5 per year at 10 percent is $18.95, that of an annuity of $3 is $11.37,
so that:
c.
At the break-even level, the payback period is equal to the project’s economic life and the internal rate of
return is equal to the project’s cost of capital. This follows directly from the definition of the discounted
10. Bid price.
The cash flows of the project are:
A B C D E F G
1Now
Year-end
1
Year-end
2
Year-end
3
Year-end
4
Year-end
5
5
The value of the cash flow, CF, for which the project’s net present value is zero, must verify the following
equation:
8-7
55432
)10.1(
000,30$
)10.1(
CF
)10.1(
CF
)10.1(
CF
)10.1(
CF
)10.1(
CF
000,130$0
or
which implies that
From equation 8.2:
(Note there is no change in working capital requirement nor any new capital expenditure expected over
the five-year period.)
The depreciation allowance is $20,000 ($100,000/5). Given this, we can write:
$29,380 = EBIT(1 – .40) + $20,000
633,15$
6.
380,9$
6.
000,20$380,29$
EBIT
but, by definition:
EBIT = Revenues – Labor and other costs – Depreciation expenses
so that
Maintainit Inc. must submit a bid of no less than $115,633 per year for the project to have a positive net
present value.
8-8
