978-1259722615 Chapter 9 Solution Manual Part 1

Solutions to Chapter 9

Using Discounted Cash-Flow Analysis to Make Investment Decisions

1. Gross revenues from new chip = 12 million  $25 = $300 million

Cost of new chip = 12 million  $8 = $96 million

2. Incremental cash flows are answers b and d:

3.

a. If the oce space would have remained unused in the absence of the proposed project,

b. One reasonable approach would be to assess a cost to the space equal to the rental

4. Net income = ($74  $42  $10)  [0.35  ($74  $42  $10)] = $22  $7.7 = $14.3

million

a. Revenues  cash expenses  taxes paid = $74  $42  $7.7 = $24.3 million

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5. Net income = ($7  $4  $1)  [0.35  ($7  $4  $1)] = $2  $0.7 = $1.3 million

6. a. False. As long as the firm has taxable income to shield, the depreciation tax shields

b. False. Regardless of the actual financing, you should view the project as if it were

7. Revenue $160,000

Rental costs 30,000

8. a. Revenue – rental costs – variable costs – taxes

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b. Net income + depreciation = $45,500 + $10,000 = $55,500

c. [(Revenue – rental costs – variable costs)  (1 – 0.35)] + (depreciation  0.35)

9. a. The machinery associated with the electric motor project is an appropriate incremental

costs. The warehouse extension would be included only to the extent that the decision

b. If the R&D costs have been spent then they fall into the category of a sunk costs and

c. The increase in working capital, exhibited here as an investment in inventories, is an

d. This note speci$es that cash !ows are in real terms, instead of nominal, and therefore

e. The indirect costs should be scrutinized in two ways. First, they should be strictly

f. The marketing and administrative costs should be strictly incremental costs contingent

g. Depreciation expense in a non-cash expense and therefore should not reduce project

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h. Financing decisions should be separate from the investment decision. The project cash

i. Income should be adjusted for all items mentioned above.

j. The tax loss carry forwards may not be realized if the firm has other profitable business

k. The net cash !ow calculation should be adjusted for all items aforementioned.

l. The net present value calculation should re!ect correctly calculated cash !ows. Also,

10. Revenue $120,000

Variable costs 40,000

11.

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If the firm uses straight-line depreciation, the present value of the cost of buying, net of

the annual depreciation tax shield (which equals $12,000  0.40 = $4,800), is:

12. a. In the following table, we compute the impact on operating cash flows by summing the

value of the depreciation tax shield (depreciation  tax rate) plus the net-of-tax

improvement in operating income [$20,000  (1 – tax rate)]. Although the MACRS

depreciation schedule extends out to 4 years, the project will be terminated when the

machine is sold after 3 years, so we need to examine cash flows for only 3 years.

MACRS Depreciation Depreciation 

0.35

Operating

Income

 (1 – 0.35)

Contribution to

Operating Cash

flow

0.3333

$13,332

$4,666.20

$13,000

$17,666.20

0.0741

b. Total cash flow = operating cash flow + cash flow associated with investments.

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Therefore, total cash flows are:

Time Cash Flow

0$40,000.00

c. The net present value of this cash-flow stream, at a discount rate of 12%, is

13. a. Annual depreciation is ($115  $15)/5 = $20 million.

b. The project saves $10 million in operating costs and increases sales by $25 million.

c. NPV = $71.75 + [$40.25  annuity factor (10%, 3 years)]

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14. a. Working capital = 20%  $40,000 = $8,000

b.

All figures in thousands of dollars

Year Revenues Expenses Working

Capital Depreciation Cash Flow*

1

40

16

6

11.25

20.9

c.

71.377,4$

12.1

100,10$

12.1

700,13$

12.1

300,17$

12.1

900,20$

000,53$NPV 432 

d. To compute IRR, use trial and error or a financial calculator to solve for r in the

15. The initial investment is $100,000 for the copier plus $10,000 in working capital, for a

total outlay of $110,000.

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16. Find the equivalent annual cost of each alternative:

Quick and Dirty Do-It-Right

Operating costs $1 million $1 million

Investment $10 million $12 million

Project life 5 years 8 years

Annual depreciation $2 million $1.5 million

Depreciation tax shield $0.700 million $0.525 million

PV(depreciation tax shield)* $2.523 million $2.608 million

Net capital cost† $7.477 million $9.392 million

EAC of net capital cost* $2.074 million $1.891 million

*Annuity discounted at 12%; number of years = project life.

†Investment – PV(depreciation tax shield).

The present value of the depreciation tax shield for each alternative is computed as

follows:

million 523.2$

)12.1(12.0

1

12.0

1

million 700.0$PV

5









million 608.2$

)12.1(12.0

1

12.0

1

million 525.0$PV

8









The equivalent annual cost (EAC) for each alternative is computed by solving for “C” as

follows:

a.

million 074.2$EACmillion 477.7$

)12.1(12.0

1

12.0

1

5







 CC

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17. All figures are on an incremental basis:

Labor savings $125,000

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