Chapter 12: The Capital Budgeting Decision
12-24. Solution:
Davis Chili Company
a. NPV @ 0% discount rate
b.
Year Cash Flow PVIF at 10% Present Value
1 $16,000 .909 $ 14,544
c.
Year Cash Flow PVIF at 15% Present Value
1 $16,000 .870 $ 13,920
2 15,000 .756 11,340
d. Net Present Value Profile
Chapter 12: The Capital Budgeting Decision
f(x) = – 68787.62x + 8000
R² = 1
Calculator Solution:
(b)
Using a financial calculator at 10 percent:
Press the following keys: 2nd, CF, 2nd, Clear.
Press down arrow, enter 1, and press Enter.
Press down arrow, enter 12,000, and press Enter.
Chapter 12: The Capital Budgeting Decision
(c)
Using a financial calculator at 20 percent:
Press the following keys: 2nd, CF, 2nd, Clear.
Press down arrow, enter 1, and press Enter.
Press down arrow, enter 12,000, and press Enter.
Chapter 12: The Capital Budgeting Decision
25. MACRS depreciation and cash flow (LO12-2) Telstar Communications is going to
purchase an asset for $380,000 that will produce $180,000 per year for the next four years
in earnings before depreciation and taxes. The asset will be depreciated using the three-year
MACRS depreciation schedule in Table 12-12. (This represents four years of depreciation
based on the half-year convention.) The firm is in a 35 percent tax bracket. Fill in the
schedule below for the next four years.
Earnings before depreciation and taxes _____
Depreciation _____
Earnings before taxes _____
Taxes _____
Earnings after taxes _____
+ Depreciation _____
Cash flow _____
12-25. Solution:
Telstar Communications Corporation
First, determine annual depreciation.
Percentage
Depreciation Depreciation Annual
Year Base (Table 12-9) Depreciation
1 $380,000 .333 $ 126,540
2 380,000 .445 169,100
Chapter 12: The Capital Budgeting Decision
Chapter 12: The Capital Budgeting Decision
1 2 3 4
EBDT $180,000 $180,000 $180,000 $180,000
– D 126,540 169,100 56,240 28,120
EBT 53,460 10,900 123,760 151,880
26. MACRS depreciation categories (LO12-4) Assume $65,000 is going to be invested in
each of the following assets. Using Tables 12-11 and 12-12, indicate the dollar amount of
the first year’s depreciation.
a. Office furniture.
b. Automobile.
c. Electric and gas utility property.
d. Sewage treatment plant.
12-26. Solution:
a. Office furniture – Based on Table 12-8, this falls under
7-year MACRS depreciation. Then, examining Table 12-9,
the first year depreciation rate is .143. Thus:
$65,000 .143 $9, 295´ =
b. Automobile – This falls under 5-year MACRS depreciation.
This first year depreciation rate is .200.
$65,000 .200 $13,000´ =
c. Electric and gas utility property – This falls under 20-year
MACRS depreciation. The first year depreciation rate is .038.
$65,000 .038 $2,470´ =
d. Sewage treatment plant – This falls under 15-year MACRS
depreciation. This first year depreciation rate is .050.
Chapter 12: The Capital Budgeting Decision
$65,000 .050 $3, 250´ =
27. MACRS depreciation and net present value (LO12-4) The Summit Petroleum
Corporation will purchase an asset that qualifies for three-year MACRS depreciation. The
cost is $160,000 and the asset will provide the following stream of earnings before
depreciation and taxes for the next four years:
Year 1………………. $70,000
Year 2………………. 85,000
Year 3………………. 42,000
Year 4………………. 40,000
The firm is in a 35 percent tax bracket and has an 8 percent cost of capital. Should it
purchase the asset? Use the net present value method.
12-27. Solution:
Summit Petroleum Corporation
First, determine annual depreciation.
Percentage
Depreciation Depreciation Annual
Year Base (Table 12-9) Depreciation
1 $160,000 .333 $53,280
2 160,000 .445 71,200
Chapter 12: The Capital Budgeting Decision
1 2 3 4
EBDT $70,000 $85,000 $42,000 $40,000
– D 53,280 71,200 23,680 11,840
12-27. (Continued)
Then, determine the net present value.
Cash Flow Present
Year (inflows) PVIF at 8% Value
1 $64,148 .926 $59,401
2 80,170 .857 68,706
Calculator Solution:
(a)
Using a financial calculator,
Press the following keys: 2nd, CF, 2nd, Clear.
Calculator displays CFo, press 160,000 +|–, press the Enter key.
Chapter 12: The Capital Budgeting Decision
Press down arrow, enter 35,588, and press Enter.
Press down arrow, enter 1, and press Enter.
Press CPT; calculator shows NPV = 18,536.79, which is the NPV of the project.
28. MACRS depreciation and net present value (LO12-4) Oregon Forest Products will
acquire new equipment that falls under the five-year MACRS category. The cost is
$300,000. If the equipment is purchased, the following earnings before depreciation and
taxes will be generated for the next six years.
Year 1…………………. $112,000
Year 2…………………. 105,000
Year 3…………………. 82,000
Year 4…………………. 53,000
Year 5…………………. 37,000
Year 6…………………. 32,000
Chapter 12: The Capital Budgeting Decision
The firm is in a 30 percent tax bracket and has a 14 percent cost of capital. Should
Oregon Forest Products purchase the equipment? Use the net present value method.
12-28. Solution:
Oregon Forest Products
First, determine annual depreciation.
Percentage
Depreciation Depreciation Annual
Year Base (Table 12-9) Depreciation
1 $300,000 .200 $ 60,000
2 300,000 .320 96,000
3 300,000 .192 57,600
Chapter 12: The Capital Budgeting Decision
12-28. (Continued)
Then, determine the annual cash flow.
Annual Cash Flow
1 2 3 4 5 6
EBDT $112,000 $105,000 $82,000 $53,000 $37,000 $32,000
– D 60,000 96,000 57,600 34,500 34,500 17,400
EBT 52,000 9,000 24,400 18,500 2,500 14,600
Then, determine the net present value.
Cash Flow Present
Year (Inflows) PVIF @ 14% Value
1 $ 96,400 .877 $ 84,543
2 102,300 .769 78,669
3 74,680 .675 50,409
Calculator Solution:
Press the following keys: 2nd, CF, 2nd, CLR WORK.
Chapter 12: The Capital Budgeting Decision
Calculator displays CFo, press 300,000 +|–, press the Enter key.
Press down arrow, enter 74,680, and press Enter.
Press down arrow, enter 1, and press Enter.
Press down arrow, enter 27,620, and press Enter.
Press down arrow, enter 1, and press Enter.
Chapter 12: The Capital Budgeting Decision
29. MACRS depreciation and net present value (LO12-4) Universal Electronics is considering
the purchase of manufacturing equipment with a 10-year midpoint in its asset depreciation
range (ADR). Carefully refer to Table 12-11 to determine in what depreciation category the
asset falls. (Hint: It is not 10 years.) The asset will cost $120,000, and it will produce earnings
before depreciation and taxes of $37,000 per year for three years, and then $19,000 a year for
seven more years. The firm has a tax rate of 40 percent. With a cost of capital of 12 percent,
should it purchase the asset? Use the net present value method. In doing your analysis, if you
have years in which there is no depreciation, merely enter a zero for depreciation.
12-29. Solution:
Universal Electronics
Because the manufacturing equipment has a 10-year midpoint
of its asset depreciation range (ADR), it falls into the 7-year
MACRS category as indicated in Table 12-8. Furthermore, we
Chapter 12: The Capital Budgeting Decision
Percentage
Depreciation Depreciation Annual
Year Base (Table 12-9) Depreciation
1 $120,000 .143 $17,160
2 120,000 .245 29,400
3 120,000 .175 21,000
Chapter 12: The Capital Budgeting Decision
12-29. (Continued)
Annual Cash Flow
12345678
EBDT $37,000 $37,000 $37,000 $19,000 $19,000 $19,000 $19,000 $19,000 $19,000
T (40%) 7,936 3,040 6,400 1,600 3,328 3,328 3,328 5,440 7,600
EAT $11,904 $ 4,560 $9,600 $ 2,400 $ 4,992 $ 4,992 $ 4,992 $ 8,160 $11,400