Fundamentals of Capital Budgeting

Chapter 7 Fundamentals of Basic Budgeting 7-1. Pisa Pizza, a agent of arctic pizza, is because introducing a convalescent adaptation of its pizza that will be low in cholesterol and accommodate no auto fats. The close expects that sales of the new pizza will be $20 actor per year. While abounding of these sales will be to new customers, Pisa Pizza estimates that 40% will appear from barter who about-face to the new, convalescent pizza instead of affairs the aboriginal version. a. b. Assume barter will absorb the aforementioned bulk on either version. What akin of incremental sales is associated with introducing the new pizza? Suppose that 50% of the barter who will about-face from Pisa Pizza’s aboriginal pizza to its convalescent pizza will about-face to accession cast if Pisa Pizza does not acquaint a convalescent pizza. What akin of incremental sales is associated with introducing the new pizza in this case? Sales of new pizza – absent sales of aboriginal = 20 – 0. 40(20) = $12 actor Sales of new pizza – absent sales of aboriginal pizza from barter who would not accept switched brands = 20 – 0. 50(0. 40)(20) = $16 actor a. b. 7-2. Kokomochi is because the barrage of an announcement attack for its latest ambrosia product, the Mini Mochi Munch. Kokomochi affairs to absorb $5 actor on TV, radio, and book announcement this year for the campaign. The ads are accustomed to accession sales of the Mini Mochi Munch by $9 actor this year and by $7 actor abutting year. In addition, the aggregation expects that new consumers who try the Mini Mochi Munch will be added acceptable to try Kokomochi’s another products. As a result, sales of another articles are accustomed to acceleration by $2 actor anniversary year. Kokomochi’s gross accumulation allowance for the Mini Mochi Munch is 35%, and its gross accumulation allowance averages 25% for all another products. The company’s bordering accumulated tax bulk is 35% both this year and abutting year. What are the incremental balance associated with the announcement campaign? A B C 1 Year 2 Incremental Balance Anticipation ($000s) 3 1 Sales of Mini Mochi Munch 4 2 Another Sales 5 3 Bulk of Appurtenances Awash 6 4 Gross Accumulation 7 5 Selling, Accustomed & Admin. 8 6 Abrasion 9 7 EBIT 10 8 Assets tax at 35% 11 9 Unlevered Net Assets D 1 9,000 2,000 (7,350) 3,650 (5,000) (1,350) 473 (878) $300 E 2 7,000 2,000 (6,050) 2,950 2,950 (1,033) 1,918 $250 ©2011 Pearson Education, Inc. Publishing as Prentice Hall $200 70 80 90 100 110 120 130 140 150 90 Berk/DeMarzo Corporate Finance, Second Edition 7-3. Home Builder Supply, a banker in the home advance industry, currently operates seven retail outlets in Georgia and South Carolina. Administration is advertent architecture an eighth retail abundance aloft boondocks from its best acknowledged retail outlet. The aggregation already owns the acreage for this store, which currently has an deserted barn amid on it. Aftermost month, the business administration spent $10,000 on bazaar assay to actuate the admeasurement of chump appeal for the new store. Now Home Builder Supply charge adjudge whether to anatomy and accessible the new store. Which of the afterward should be included as allotment of the incremental balance for the proposed new retail store? a. b. c. d. e. f. g. a. b. c. d. e. f. The bulk of the acreage area the abundance will be located. The bulk of abolition the deserted barn and allowance the lot. The accident of sales in the absolute retail outlet, if barter who ahead collection aloft boondocks to boutique at the absolute aperture become barter of the new abundance instead. The $10,000 in bazaar assay spent to appraise chump demand. Architecture costs for the new store. The bulk of the acreage if sold. Absorption bulk on the debt adopted to pay the architecture costs. No, this is a sunk bulk and will not be included directly. (But see (f) below. ) Yes, this is a bulk of aperture the new store. Yes, this accident of sales at the absolute abundance should be deducted from the sales at the new abundance to actuate the incremental access in sales that aperture the new abundance will accomplish for HBS. No, this is a sunk cost. This is a basic bulk associated with aperture the new store. These costs will, therefore, access HBS’s abrasion expenses. Yes, this is an befalling bulk of aperture the new store. (By aperture the new store, HBS forgoes the after-tax accretion it could accept becoming by affairs the property. This accident is according to the auction bulk beneath the taxes owed on the basic accretion from the sale, which is the aberration amid the auction bulk and the book bulk of the property. The book bulk equals the antecedent bulk of the acreage beneath accumulated depreciation. ) While these costs costs will affect HBS’s absolute earnings, for basic allotment purposes we anniversary the incremental balance afterwards including costs costs to actuate the project’s unlevered net income. g. 7-4. Hyperion, Inc. currently sells its latest accelerated blush printer, the Hyper 500, for $350. It affairs to lower the bulk to $300 abutting year. Its bulk of appurtenances awash for the Hyper 500 is $200 per unit, and this year’s sales are accustomed to be 20,000 units. a. Accept that if Hyperion drops the bulk to $300 immediately, it can access this year’s sales by 25% to 25,000 units. What would be the incremental appulse on this year’s EBIT of such a bulk drop? Accept that for anniversary printer sold, Hyperion expects added sales of $75 per year on ink cartridges for the abutting three years, and Hyperion has a gross accumulation allowance of 70% on ink cartridges. What is the incremental appulse on EBIT for the abutting three years of a bulk bead this year? b. ©2011 Pearson Education, Inc. Publishing as Prentice Hall Berk/DeMarzo • Accumulated Finance, Second Edition Change in EBIT = Gross accumulation with bulk bead – Gross accumulation afterwards bulk bead = 25,000 ? (300 – 200) – 20,000 ? (350 – 200) = – $500,000 b. Change in EBIT from Ink Cartridge sales = 25,000 ? $75 ? 0. 70 – 20,000 ? $75 ? 0. 70 = $262,500 Therefore, incremental change in EBIT for the abutting 3 years is Year 1: Year 2: Year 3: 7-5. $262,500 – 500,000 = -$237,500 $262,500 $262,500 91 a. Afterwards attractive at the projections of the HomeNet project, you adjudge that they are not realistic. It is absurd that sales will be connected over the four-year activity of the project. Furthermore, another companies are acceptable to action aggressive products, so the acceptance that the sales bulk will abide connected is additionally acceptable to be optimistic. Finally, as assembly ramps up, you ahead lower per assemblage assembly costs consistent from economies of scale. Therefore,you adjudge to accommodate the projections beneath the afterward assumptions: Sales of 50,000 units in year 1 accretion by 50,000 units per year over the activity of the project, a year 1 sales bulk of $260/unit, abbreviating by 10% annually and a year 1 bulk of $120/unit abbreviating by 20% annually. In addition, new tax laws acquiesce you to abate the accessories over three rather than bristles years application straightline depreciation. a. Keeping the another assumptions that underlie Table 7. 1 the same, recalculate unlevered net assets (that is, carbon Table 7. 1 beneath the new assumptions, and agenda that we are blank cannibalization and absent rent). Recalculate unlevered net assets assuming, in addition, that anniversary year 20% of sales comes from barter who would accept purchased an absolute Linksys router for $100/unit and that this router costs $60/unit to manufacture. (15,000) (15,000) 6,000 (9,000) 1 13,000 (6,000) 7,000 (2,800) (2,500) 1,700 (680) 1,020 2 23,400 (9,600) 13,800 (2,800) (2,500) 8,500 (3,400) 5,100 3 31,590 (11,520) 20,070 (2,800) (2,500) 14,770 (5,908) 8,862 4 37,908 (12,288) 25,620 (2,800) 22,820 (9,128) 13,692 5 - b. a. Year Incremental Balance Anticipation ($000s) 1 Sales 2 Bulk of Appurtenances Awash 3 Gross Accumulation 4 Selling, Accustomed & Admin. 5 Assay & Development 6 Abrasion 7 EBIT 8 Assets tax at 40% 9 Unlevered Net Assets ©2011 Pearson Education, Inc. Publishing as Prentice Hall 92 Berk/DeMarzo • Accumulated Finance, Second Edition b. Year Incremental Balance Anticipation ($000s) 1 Sales 2 Bulk of Appurtenances Awash 3 Gross Accumulation 4 Selling, Accustomed & Admin. 5 Assay & Development 6 Abrasion 7 EBIT 8 Assets tax at 40% 9 Unlevered Net Assets 7-6. 0 (15,000) (15,000) 6,000 (9,000) 1 12,000 (5,400) 6,600 (2,800) (2,500) 1,300 (520) 780 2 21,400 (8,400) 13,000 (2,800) (2,500) 7,700 (3,080) 4,620 3 28,590 (9,720) 18,870 (2,800) (2,500) 13,570 (5,428) 8,142 4 33,908 (9,888) 24,020 (2,800) 21,220 (8,488) 12,732 5 - Cellular Access, Inc. is a cellular blast anniversary provider that appear net assets of $250 actor for the best contempo budgetary year. The close had abrasion costs of $100 million, basic expenditures of $200 million, and no absorption expenses. Alive basic added by $10 million. Anniversary the chargeless banknote breeze for Cellular Access for the best contempo budgetary year. FCF = Unlevered Net Assets + Abrasion – CapEx – Access in NWC= 250 + 100 – 200 – 10 = $140 million. 7-7. Castle View Amateur would like to advance in a assay to advance software for video games. To appraise this decision, the close aboriginal attempts to activity the alive basic needs for this operation. Its arch banking administrator has developed the afterward estimates (in millions of dollars): Bold that Castle View currently does not accept any alive basic invested in this division, anniversary the banknote flows associated with changes in alive basic for the aboriginal bristles years of this investment. Year0 1 2 3 4 5 6 Banknote Accounts Receivable Account Accounts Payable Net alive basic (1+2+3-4) Access in NWC Year1 6 21 5 18 14 14 Year2 12 22 7 22 19 5 Year3 15 24 10 24 25 6 Year4 15 24 12 25 26 1 Year5 15 24 13 30 22 -4 0 2011 Pearson Education, Inc. Publishing as Prentice Hall Berk/DeMarzo • Accumulated Finance, Second Edition 93 7-8. Mersey Chemicals articles polypropylene that it ships to its barter via catchbasin car. Currently, it affairs to add two added catchbasin cars to its agile four years from now. However, a proposed bulb amplification will crave Mersey’s carriage assay to add these two added catchbasin cars in two years’ time rather than in four years. The accustomed bulk of a catchbasin car is $2 million, and this bulk is accustomed to abide constant. Also, while catchbasin cars will aftermost indefinitely, they will be attenuated straight-line over a five-year activity for tax purposes. Accept Mersey’s tax bulk is 40%. Back evaluating the proposed expansion, what incremental chargeless banknote flows should be included to anniversary for the charge to advance the acquirement of the catchbasin cars? antecedent catchbasin car bulk aggrandizement bulk depreciable activity Year: with amplification CapEx Abrasion Tax Absorber FCF afterwards amplification CapEx Abrasion Tax Absorber FCF Incremental FCF (with-without) 0 1 4 0% 5 2 -4 0 0 -4 0. 32 0. 32 0. 32 0. 32 0. 2 0. 32 0. 32 0. 32 0. 32 0. 32 0 0 0 3 alter date afterwards amplification alter date with amplification tax bulk 4 5 6 7 4 2 40% 8 9 10 -4 0 0 0 0 0 -4 0 0. 32 -4 4. 32 0. 32 0. 32 0 0. 32 0. 32 0 0. 32 0. 32 0 0. 32 0. 32 -0. 32 0. 32 0. 32 -0. 32 0 0 7-9. Elmdale Enterprises is chief whether to aggrandize its assembly facilities. Although abiding banknote flows are difficult to estimate, administration has projected the afterward banknote flows for the aboriginal two years (in millions of dollars): a. b. a. What are the incremental balance for this activity for years 1 and 2? What are the chargeless banknote flows for this activity for the aboriginal two years? Year Incremental Balance Anticipation ($000s) 1 Sales 2 Costs of acceptable awash and operating costs another than abrasion 3 Abrasion 4 EBIT 5 Assets tax at 35% 6 Unlevered Net Assets 1 125. 0 (40. 0) (25. 0) 60. 0 (21. 0) 39. 0 2 160. 0 (60. 0) (36. 0) 64. 0 (22. 4) 41. 6 b. Chargeless Banknote Breeze ($000s) 7 Plus: Abrasion 8 Less: Basic Expenditures 9 Less: Increases in NWC 10 Chargeless Banknote Breeze 1 25. 0 (30. 0) (5. 0) 29. 0 2 36. 0 (40. 0) (8. 0) 29. 6 ©2011 Pearson Education, Inc. Publishing as Prentice Hall 94 Berk/DeMarzo Corporate Finance, Second Edition 7-10. You are a administrator at Percolated Fiber, which is because accretion its operations in constructed cilia manufacturing. Your bang-up comes into your office, drops a consultant’s address on your desk, and complains, “We owe these consultants $1 actor for this report, and I am not abiding their assay makes sense. Afore we absorb the $25 actor on new accessories bare for this project, attending it over and accord me your opinion. ” You accessible the address and acquisition the afterward estimates (in bags of dollars): All of the estimates in the address assume correct. You agenda that the consultants acclimated straight-line abrasion for the new accessories that will be purchased today (year 0), which is what the accounting administration recommended. The address concludes that because the activity will access balance by $4. 875 actor per year for 10 years, the activity is account $48. 75 million. You anticipate aback to your advantageous canicule in accounts chic and apprehend there is added assignment to be done! First, you agenda that the consultants accept not factored in the actuality that the activity will crave $10 actor in alive basic upfront (year 0), which will be absolutely recovered in year 10. Next, you see they accept attributed $2 actor of selling, accustomed and authoritative costs to the project, but you apperceive that $1 actor of this bulk is aerial that will be incurred alike if the activity is not accepted. Finally, you apperceive that accounting balance are not the adapted affair to focus on! a. b. a. Accustomed the accessible information, what are the chargeless banknote flows in years 0 through 10 that should be acclimated to appraise the proposed project? If the bulk of basic for this activity is 14%, what is your appraisal of the bulk of the new project? Chargeless Banknote Flows are: 0 = Net assets + Aerial (after tax at 35%) + Abrasion – Capex – Inc. n NWC FCF b. 1 4,875 650 2,500 2 4,875 650 2,500 … 9 4,875 650 2,500 10 4,875 650 2,500 –10000 18,025 25,000 10,000 –35,000 8,025 8,025 … 8,025 NPV ? ?35 ? 8. 025 ? 1 ? 1 ? 18. 025 ? 9. 56 ? 1 ? ?? .14 ? 1. 149 ? 1. 1410 ©2011 Pearson Education, Inc. Publishing as Prentice Hall Berk/DeMarzo Corporate Finance, Second Edition 95 7-11. Application the assumptions in allotment a of Problem 5 (assuming there is no cannibalization), a. b. a. Anniversary HomeNet’s net alive basic requirements (that is, carbon Table 7. 4 beneath the assumptions in Problem 5(a)). Anniversary HomeNet’s FCF (that is, carbon Table 7. beneath the aforementioned assumptions as in (a)). 0 1 13,000 (6,000) 7,000 (2,800) (2,500) 1,700 (680) 1,020 2,500 (1,050) 2,470 1 1,950 (900) 1,050 2 23,400 (9,600) 13,800 (2,800) (2,500) 8,500 (3,400) 5,100 2,500 (1,020) 6,580 2 3,510 (1,440) 2,070 3 31,590 (11,520 ) 20,070 (2,800) (2,500) 14,770 (5,908) 8,862 2,500 (941) 10,421 3 4,739 (1,728) 3,011 4 37,908 (12,288 ) 25,620 (2,800) 22,820 (9,128) 13,692 (833) 12,860 4 5,686 (1,843) 3,843 5 3,843 3,843 5 - Year Net Alive Basic Anticipation ($000s) 1 Banknote requirements 2 Account 3 Receivables (15% of Sales) 4 Payables (15% of COGS) 5 Net Alive Basic b. Year 0 Incremental Balance Anticipation ($000s) 1 Sales 2 3 4 5 6 7 8 9 Bulk of Appurtenances Awash Gross Accumulation Selling, Accustomed & Admin. Assay & Development Abrasion EBIT Incometaxat40% Unlevered Net Assets (15,000) (15,000) 6,000 (9,000) (7,500) (16,500) Chargeless Banknote Breeze ($000s) 10 Plus: Abrasion Less: Basic 11 Expenditures 12 Less: Increases in NWC 13 Chargeless Banknote Breeze 7-12. A bike architect currently produces 300,000 units a year and expects achievement levels to abide abiding in the future. It buys chains from an alfresco supplier at a bulk of $2 a chain. The bulb administrator believes that it would be cheaper to accomplish these chains rather than buy them. Direct centralized assembly costs are estimated to be alone $1. 50 per chain. The all-important accouterment would bulk $250,000 and would be anachronistic afterwards 10 years. This advance could be attenuated to aught for tax purposes application a 10-year straight-line abrasion schedule. The bulb administrator estimates that the operation would crave added alive basic of $50,000 but argues that this sum can be abandoned back it is recoverable at the end of the 10 years. Accustomed accretion from auctioning the accouterment afterwards 10 years are $20,000. If the aggregation pays tax at a bulk of 35% and the befalling bulk of basic is 15%, what is the net present bulk of the accommodation to aftermath the chains centralized instead of purchasing them from the supplier? Solution: FCF=EBIT (1-t) + abrasion – CAPX – ? NWC FCF from alfresco supplier = -$2x300,000 x (1 – . 35) = -$390k per year. ©2011 Pearson Education, Inc. Publishing as Prentice Hall 96 Berk/DeMarzo Corporate Finance, Second Edition NPV(outside) ? ?$390, 000 1 ? 1 ? ?1 ? ? 0. 15 ? 1. 1510 ? ? ? $1. 9573M FCF in house: in year 0: – 250 CAPX – 50 NWC= – 300K FCF in years 1-9: ?$1. 50 x 300,000 ? 25,000 -$475,000 bulk ? abrasion = incremental EBIT ? tax = (1-t) x EBIT + abrasion = FCF ?$166, 250 -$308,750 +$25,000 -$283,750 FCF in year 10: –$283,750 + (1 – 0. 35) x $20,000 + $50,000 = –$220,750 FCF Agenda that the book bulk of the accouterment is zero; hence, its atom accretion ($20,000) are absolutely taxed. The NWC ($50,000) is recovered at book bulk and appropriately not taxed. NPV (in house): –$300k + accomplishment of –$283,750 for 9 years + ?$220, 750 1. 1510 $283, 750 ? 1 ? 1 ? 0. 15 ? 1. 159 ? ?$1. 7085M ? ?$300k ? ? $220, 750 ?? 1. 1510 ? Thus, centralized is cheaper, with a bulk accumulation of ($1. 573M - $1. 7085M) = $248. 8K in present bulk terms. 7-13. One year ago, your aggregation purchased a apparatus acclimated in accomplishment for $110,000. You accept abstruse that a new apparatus is accessible that offers abounding advantages; you can acquirement it for $150,000 today. It will be attenuated on a straight-line base over 10 years, afterwards which it has no deliver value. You apprehend that the new apparatus will aftermath EBITDA (earning afore interest, taxes, depreciation, and amortization) of $40,000 per year for the abutting 10 years. The accustomed apparatus is accustomed to aftermath EBITDA of $20,000 per year. The accustomed apparatus is actuality attenuated on a straight-line base over a advantageous activity of 11 years, afterwards which it will accept no deliver value, so abrasion bulk for the accustomed apparatus is $10,000 per year. All another costs of the two machines are identical. The bazaar bulk today of the accustomed apparatus is $50,000. Your company’s tax bulk is 45%, and the befalling bulk of basic for this blazon of accessories is 10%. Is it assisting to alter the year-old machine? Replacing the apparatus increases EBITDA by 40,000 – 20,000 = 20,000. Abrasion costs rises by $15,000 – $10,000 = $5,000. Therefore, FCF will access by (20,000) ? (1-0. 45) + (0. 45)(5,000) = $13,250 in years 1 through 10. In year 0, the antecedent bulk of the apparatus is $150,000. Because the accustomed apparatus has a book bulk of $110,000 – 10,000 (one year of depreciation) = $100,000, affairs it for $50,000 generates a basic ©2011 Pearson Education, Inc. Publishing as Prentice Hall Berk/DeMarzo • Accumulated Finance, Second Edition 97 accretion of 50,000 – 100,000 = –50,000. This accident produces tax accumulation of 0. 45 ? 50,000 = $22,500, so that the after-tax accretion from the sales including this tax accumulation is $72,500. Thus, the FCF in year 0 from backup is –150,000 + 72,500 = –$77,500. NPV of backup = –77,500 + 13,250 ? (1 / . 10)(1 – 1 / 1. 1010) = $3916. There is a baby accumulation from replacing the machine. 7-14. Beryl’s Iced Tea currently rents a bottling apparatus for $50,000 per year, including all aliment expenses. It is because purchasing a apparatus instead, and is comparing two options: a. b. Acquirement the apparatus it is currently renting for $150,000. This apparatus will crave $20,000 per year in advancing aliment expenses. Acquirement a new, added avant-garde apparatus for $250,000. This apparatus will crave $15,000 per year in advancing aliment costs and will lower bottling costs by $10,000 per year. Also, $35,000 will be spent upfront in training the new operators of the machine. Accept the adapted abatement bulk is 8% per year and the apparatus is purchased today. Aliment and bottling costs are paid at the end of anniversary year, as is the rental of the machine. Assume additionally that the machines will be attenuated via the straight-line adjustment over seven years and that they accept a 10-year activity with a negligible deliver value. The bordering accumulated tax bulk is 35%. Should Beryl’s Iced Tea abide to rent, acquirement its accustomed machine, or acquirement the avant-garde machine? We can use Eq. 7. 5 to appraise the chargeless banknote flows associated with anniversary alternative. Agenda that we alone charge to accommodate the apparatus of chargeless banknote flows that alter aloft anniversary alternative. For example, back NWC is the aforementioned for anniversary alternative, we can avoid it. The spreadsheet beneath computes the accordant FCF from anniversary alternative. Agenda that anniversary another has a abrogating NPV—this represents the PV of the costs of anniversary alternative. We should accept the one with the accomplished NPV (lowest cost), which in this case is purchasing the absolute machine. a. b. See spreadsheet See spreadsheet D 0 A B C 5 6 Hire Apparatus 7 1 Hire 8 2 FCF(rent) 9 3 NPV at 8% 10 Acquirement Accustomed Apparatus 11 4 Aliment 12 5 Abrasion 13 6 Basic Expenditures 14 7 FCF(purchase current) 15 8 NPV at 8% 16 Acquirement Avant-garde Apparatus 17 9 Aliment 18 10 Another Costs 19 11 Abrasion 20 12 Basic Expenditures 21 13 FCF(purchase advanced) 22 14 NPV at 8% E 1 (50,000) (32,500) F 2 (50,000) (32,500) G 3 (50,000) (32,500) H 4 (50,000) (32,500) I 5 (50,000) (32,500) J 6 (50,000) (32,500) K 7 (50,000) (32,500) L 8 (50,000) (32,500) M 9 (50,000) (32,500) N 10 (50,000) (32,500) (218,078) (20,000) 21,429 (150,000) (150,000) (198,183) (5,500) (20,000) 21,429 (5,500) (20,000) 21,429 (5,500) (20,000) 21,429 (5,500) (20,000) 21,429 (5,500) (20,000) 21,429 (5,500) (20,000) 21,429 (5,500) (20,000) (13,000) (20,000) (13,000) (20,000) (13,000) (35,000) (250,000) (272,750) (229,478) (15,000) 10,000 35,714 9,250 (15,000) 10,000 35,714 9,250 (15,000) 10,000 35,714 9,250 (15,000) 10,000 35,714 9,250 (15,000) 10,000 35,714 9,250 15,000) 10,000 35,714 9,250 (15,000) 10,000 35,714 9,250 (15,000) 10,000 (3,250) (15,000) 10,000 (3,250) (15,000) 10,000 (3,250) 7-15. Markov Accomplishment afresh spent $15 actor to acquirement some accessories acclimated in the accomplish of deejay drives. The close expects that this accessories will accept a advantageous activity of bristles years, and its bordering accumulated tax bulk is 35%. The aggregation affairs to use straight-line depreciation. a. b. What is the anniversary abrasion bulk associated with this equipment? What is the anniversary abrasion tax shield? ©2011 Pearson Education, Inc. Publishing as Prentice Hall 98 Berk/DeMarzo Corporate Finance, Second Edition c. Rather than straight-line depreciation, accept Markov will use the MACRS abrasion adjustment for five-year property. Anniversary the abrasion tax absorber anniversary year for this accessories beneath this accelerated abrasion schedule. If Markov has a best amid straight-line and MACRS abrasion schedules, and its bordering accumulated tax bulk is accustomed to abide constant, which should it choose? Why? How adeptness your acknowledgment to allotment (d) change if Markov anticipates that its bordering accumulated tax bulk will access essentially over the abutting bristles years? 15 actor / 5 years = $3 actor per year $3 actor ? 35% = $1. 05 actor per year Year MACRS Abrasion Accessories Bulk MACRS Abrasion Bulk Abrasion Bulk Abrasion Tax Absorber (at 35% tax rate) 0 15,000 20. 00% 3,000 1,050 1 2 3 4 5 d. e. a. b. c. 32. 00% 4,800 1,680 19. 20% 2,880 1,008 11. 52% 1,728 605 11. 52% 1,728 605 5. 76% 864 302 d. In both cases, its absolute abrasion tax absorber is the same. But with MACRS, it receives the abrasion tax bouncer sooner—thus, MACRS abrasion leads to a college NPV of Markov’s FCF. If the tax bulk will access substantially, than Markov may be bigger off claiming college abrasion costs in afterwards years, back the tax account at that time will be greater. e. 7-16. Your close is because a activity that would crave purchasing $7. 5 actor account of new equipment. Actuate the present bulk of the abrasion tax absorber associated with this accessories if the firm’s tax bulk is 40%, the adapted bulk of basic is 8%, and the accessories can be attenuated a. b. c. d. Straight-line over a 10-year period, with the aboriginal answer starting in one year. Straight-line over a five-year period, with the aboriginal answer starting in one year. Application MACRS abrasion with a five-year accretion aeon and starting immediately. Absolutely as an actual deduction. Accessories Bulk Tax Bulk Amount of basic 7. 5 40. 00% 8. 00% Year 2 0. 3 0. 6 19. 20% 0. 576 Abrasion Tax Absorber (Tc*Dep) Year 3 Year 4 Year 5 Year 6 0. 3 0. 3 0. 3 0. 3 0. 6 0. 6 0. 6 11. 52% 11. 52% 5. 76% 0. 3456 0. 3456 0. 1728 Year 7 0. 3 Year 8 0. 3 Year 9 0. 3 Year 10 0. 3 PV(DTS) a 2. 013 b 2. 396 MACRS table c 2. 629 d 3. 000 Year 0 20% 0. 6 3 Year 1 0. 0. 6 32% 0. 96 7-17. Arnold Inc. is because a angle to accomplish high-end protein confined acclimated as aliment supplements by anatomy builders. The activity requires use of an absolute warehouse, which the close acquired three years ago for $1m and which it currently rents out for $120,000. Rental ante are not accustomed to change activity forward. In accession to application the warehouse, the activity requires an up-front advance into machines and another accessories of $1. 4m. This advance can be absolutely attenuated straight-line over the abutting 10 years for tax purposes. However, Arnold Inc. expects to abolish the activity at the end of eight years and to advertise the machines and accessories for $500,000. Finally, the activity requires an antecedent advance into net alive basic according to ©2011 Pearson Education, Inc. Publishing as Prentice Hall Berk/DeMarzo • Accumulated Finance, Second Edition 99 10% of predicted first-year sales. Subsequently, net alive basic is 10% of the predicted sales over the afterward year. Sales of protein confined are accustomed to be $4. 8m in the aboriginal year and to break connected for eight years. Total accomplishment costs and operating costs (excluding depreciation) are 80% of sales, and profits are burdened at 30%. a. b. a. What are the chargeless banknote flows of the project? If the bulk of basic is 15%, what is the NPV of the project? Assumptions: (1) The barn can be busy out afresh for $120,000 afterwards 8 years. (2) The NWC is absolutely recovered at book bulk afterwards 8 years. FCF = EBIT (1 – t) + Abrasion – CAPX – Change in NWC FCF in year 0: – 1. 4m CAPX – 0. 48m Change in NWC = –1. 88m FCF in years 1-7: $4. 8m –$3. 84m $0. 96m –$0. 12m –$0. 14m $0. 70m –$0. 21m $0. 49m $0. 14m $0. 63m Sales –Cost (80%) =Gross Accumulation –Lost Hire –Depreciation =EBIT –Tax (30%) = (1 – t) x EBIT +Depreciation = FCF Agenda that there is no added CAPX nor advance into NWC in years 1–7. FCF in year 8: $0. 63m + [$0. 5m – 0. 30 x ($0. 5m – $0. 28m)] + $0. 48m = $1. 544m Agenda that the book bulk of the accouterment is still $0. 28m back sold, and alone the aberration amid the auction bulk ($0. 5m) and the book bulk is taxed. The NWC ($0. 48m) is recovered at book bulk and appropriately its auction is not burdened at all. b. The NPV is the present bulk of the FCFs in years 0 to 8: NPV= -$1. 88m + an accomplishment of $0. 63m for 7 years + 1. 544m 1. 158 ? ? $1. 88m ? ? $1. 2458m $0. 63m ? 1 ? $1. 544m ? 1 ? ?? 0. 15 ? 1. 157 ? 1. 158 ©2011 Pearson Education, Inc. Publishing as Prentice Hall 100 Berk/DeMarzo  Corporate Finance, Second Edition 7-18. Bay Properties is because starting a bartering absolute acreage division. It has able the afterward four-year anticipation of chargeless banknote flows for this division: Assume banknote flows afterwards year 4 will abound at 3% per year, forever. If the bulk of basic for this assay is 14%, what is the assiduity bulk in year 4 for banknote flows afterwards year 4? What is the bulk today of this division? The accustomed banknote breeze in year 5 is 240,000 ? 1. 03 = 247,200. We can bulk the banknote flows in year 5 and aloft as a growing perpetuity: Assiduity Bulk in Year 4 = 247,200/(0. 14 – 0. 03) = $2,247,273 We can again compute the bulk of the assay by discounting the FCF in years 1 through 4, calm with the assiduity value: NPV ? 7-19. ?185, 000 ? 12, 000 99, 000 240, 000 ? 2, 247, 273 ? ? ? ? $1,367,973 1. 14 1. 142 1. 143 1. 144 Your close would like to appraise a proposed new operating division. You accept forecasted banknote flows for this assay for the abutting bristles years, and accept estimated that the bulk of basic is 12%. You would like to appraisal a assiduity value. You accept fabricated the afterward forecasts for the aftermost year of your five-year forecasting border (in millions of dollars): a. b. You anticipation that approaching chargeless banknote flows afterwards year 5 will abound at 2% per year, forever. Appraisal the assiduity bulk in year 5, application the perpetuity with advance formula. You accept articular several firms in the aforementioned industry as your operating division. The boilerplate P/E arrangement for these firms is 30. Appraisal the assiduity bulk bold the P/E arrangement for your assay in year 5 will be the aforementioned as the boilerplate P/E arrangement for the commensurable firms today. The boilerplate market/book arrangement for the commensurable firms is 4. 0. Appraisal the assiduity bulk application the market/book ratio. FCF in year 6 = 110 ? 1. 02 = 112. 2 Assiduity Bulk in year 5 = 112. 2 / (12% – 2%) = $1,122. c. a. b. We can appraisal the assiduity bulk as follows: Assiduity Bulk in year 5 = (Earnings in year 5) ? (P/E arrangement in year 5) = $50 ? 30 = $1500. c. We can appraisal the assiduity bulk as follows: Assiduity Bulk in year 5 = (Book bulk in year 5) ? (M/B arrangement in year 5) = $400 ? 4 = $1600. ©2011 Pearson Education, Inc. Publishing as Prentice Hall Berk/DeMarzo Corporate Finance, Second Edition 01 7-20. In September 2008, the IRS afflicted tax laws to acquiesce banks to advance the tax accident carryforwards of banks they access to absorber their approaching assets from taxes (prior law belted the adeptness of acquirers to use these credits). Accept Fargo Bank acquires Covia Bank and with it acquires $74 billion in tax accident carryforwards. If Fargo Bank is accustomed to accomplish taxable assets of 10 billion per year in the future, and its tax bulk is 30%, what is the present bulk of these acquired tax accident carryforwards accustomed a bulk of basic of 8%? We can absorber $10 billion per year for the abutting 7 years, and $4 billion in year 8. Given a tax bulk of 30%, this represents of tax accumulation of $3 billion in years 1–7, and $1. 2 billion in year 8. PV = 3 ? 1 ? 1 ? 1. 2 ? $16. 27 B ? 1 ? ?? .08 ? 1. 087 ? 1. 088 7-21. Application the FCF projections in allotment b of Problem 11, anniversary the NPV of the HomeNet activity bold a bulk of basic of a. b. c. 10%. 12%. 14%. What is the IRR of the activity in this case? a. Year Net Present Bulk ($000s) 1 2 3 Chargeless Banknote Breeze Activity Bulk of Basic Abatement Factor (16,500) 10% 1. 000 Year 1 2 3 PV of Chargeless Banknote Breeze NPV IRR 0 (16,500) 10,182 28. 8% 0. 909 1 2,245 0. 826 2 5,438 0. 751 3 7,830 0. 683 4 8,783 0. 21 5 2,386 2,470 6,580 10,421 12,860 3,843 0 1 2 3 4 5 b. Year Net Present Bulk ($000s) 1 2 3 Chargeless Banknote Breeze Activity Bulk of Basic Abatement Factor (16,500) 12% 1. 000 Year 1 2 3 PV of Chargeless Banknote Breeze NPV IRR 0 (16,500) 8,722 28. 8% 0. 893 1 2,205 0. 797 2 5,246 0. 712 3 7,418 0. 636 4 8,172 0. 567 5 2,181 2,470 6,580 10,421 12,860 3,843 0 1 2 3 4 5 ©2011 Pearson Education, Inc. Publishing as Prentice Hall 102 Berk/DeMarzo • Accumulated Finance, Second Edition c. Year Net Present Bulk ($000s) 1 2 3 Chargeless Banknote Breeze Activity Bulk of Basic Abatement Factor (16,500) 14% 1. 000 Year 1 2 3 7-22. PV of Chargeless Banknote Breeze NPV IRR 0 (16,500) 7,374 28. % 0. 877 1 2,167 0. 769 2 5,063 0. 675 3 7,034 0. 592 4 7,614 0. 519 5 1,996 2,470 6,580 10,421 12,860 3,843 0 1 2 3 4 5 For the assumptions in allotment (a) of Problem 5, bold a bulk of basic of 12%, anniversary the following: a. b. a. b. The break-even anniversary sales bulk decline. The break-even anniversary assemblage sales increase. 28. 5% 25350 7-24. Billingham Packaging is because accretion its assembly accommodation by purchasing a new machine, the XC-750. The bulk of the XC-750 is $2. 75 million. Unfortunately, installing this apparatus will booty several months and will partially agitate production. The close has aloof completed a $50,000 achievability abstraction to assay the accommodation to buy the XC-750, consistent in the afterward estimates: ¦ Marketing: Once the XC-750 is operating abutting year, the added accommodation is accustomed to accomplish $10 actor per year in added sales, which will abide for the 10-year activity of the machine. Operations: The disruption acquired by the accession will abatement sales by $5 actor this year. Once the apparatus is operating abutting year, the bulk of appurtenances for the articles produced by the XC-750 is accustomed to be 70% of their auction price. The added assembly will crave added account on duke of $1 actor to be added in year 0 and depleted in year 10. Human Resources: The amplification will crave added sales and authoritative cadre at a bulk of $2 actor per year. Accounting: The XC-750 will be attenuated via the straight-line adjustment over the 10-year activity of the machine. The close expects receivables from the new sales to be 15% of revenues and payables to be 10% of the bulk of appurtenances sold. Billingham’s bordering accumulated tax bulk is 35%. Actuate the incremental balance from the acquirement of the XC-750. Determine the chargeless banknote breeze from the acquirement of the XC-750. If the adapted bulk of basic for the amplification is 10%, compute the NPV of the purchase. While the accustomed new sales will be $10 actor per year from the expansion, estimates ambit from $8 actor to $12 million. What is the NPV in the affliction case? In the best case? What is the break-even akin of new sales from the expansion? What is the break-even akin for the bulk of appurtenances sold? ¦ ¦ ¦ a. b. c. d. e. ©2011 Pearson Education, Inc. Publishing as Prentice Hall Berk/DeMarzo • Accumulated Finance, Second Edition 103 f. Billingham could instead acquirement the XC-900, which offers alike greater capacity. The bulk of the XC-900 is $4 million. The added accommodation would not be advantageous in the aboriginal two years of operation, but would acquiesce for added sales in years 3–10. What akin of added sales (above the $10 actor accustomed for the XC-750) per year in those years would absolve purchasing the beyond machine? See spreadsheet on abutting page. See spreadsheet on abutting page. See spreadsheet on abutting page. See abstracts tables in spreadsheet on abutting page. See abstracts tables in spreadsheet on abutting page. See spreadsheet on abutting page—need added sales of $11. 84 actor in years 3–10 for beyond apparatus to accept a college NPV than XC-750. 0 -5,000 3,500 1 10,000 -7,000 -2,000 -275 725 -254 471 275 -1,200 -454 2 10,000 -7,000 -2,000 -275 725 -254 471 275 0 746 3 10,000 -7,000 -2,000 -275 725 -254 471 275 0 746 4 10,000 -7,000 -2,000 -275 725 -254 471 275 0 746 5 10,000 -7,000 -2,000 -275 725 -254 471 275 0 746 6 10,000 -7,000 -2,000 -275 725 -254 471 275 0 746 7 10,000 -7,000 -2,000 -275 725 -254 471 275 0 746 8 10,000 -7,000 -2,000 -275 725 -254 471 275 0 746 9 10,000 -7,000 -2,000 -275 725 -254 471 275 0 746 10 10,000 -7,000 -2,000 -275 725 -254 471 275 1,000 1,746 . b. c. d. e. f. Incremental Effects (with vs. afterwards XC-750) Year Sales Revenues Bulk of Appurtenances Awash S, G & A Costs Abrasion EBIT Taxes at 35% Unlevered Net Assets Abrasion Basic Expenditures Add. To Net Work. Cap. FCF Bulk of Basic PV(FCF) NPV Net Alive Basic Calculation Year Receivables at 15% Payables at 10% Account NWC -1,500 525 -975 -2,750 -600 -4,325 10. 00% -4,325 -164. 6 -413 617 561 510 463 421 383 348 316 673 0 -750 350 1000 600 1 1500 -700 1000 1800 2 1500 -700 1000 1800 3 1500 -700 1000 1800 4 1500 -700 1000 1800 5 1500 -700 1000 1800 6 1500 -700 1000 1800 1500 -700 1000 1800 8 1500 -700 1000 1800 9 1500 -700 1000 1800 10 1500 -700 0 800 New Sales (000s) NPV 8 -2472 Sensitivity Analysis: New Sales 9 10 10. 143 -1318 -165 0 11 989 12 2142 COGS 67% Sensitivity Analysis: Bulk of Appurtenances Awash 68% 69. 545% 69% 70% 71% ©2011 Pearson Education, Inc. Publishing as Prentice Hall 104 Berk/DeMarzo Corporate Finance, Second Edition Incremental Effects (with vs. afterwards XC-900) Year Sales Revenues Bulk of Appurtenances Awash S, G & A Costs Abrasion EBIT Taxes at 35% Unlevered Net Assets Abrasion Basic Expenditures Add. To Net Work. Cap. FCF Bulk of Basic PV(FCF) NPV Net Alive Basic Calculation Year Receivables at 15% Payables at 10% Account NWC 0 -5,000 3,500 1 10,000 -7,000 -2,000 -400 600 -210 390 400 -1,200 -410 2 10,000 -7,000 -2,000 -400 600 -210 390 400 0 790 3 11,384 -7,969 -2,000 -400 1,015 -355 660 400 -111 949 4 11,384 -7,969 -2,000 -400 1,015 -355 660 400 0 1,060 5 11,384 -7,969 -2,000 -400 1,015 -355 660 400 0 1,060 6 11,384 -7,969 -2,000 -400 1,015 -355 660 400 0 1,060 7 11,384 -7,969 -2,000 -400 1,015 -355 660 400 0 1,060 8 11,384 -7,969 -2,000 -400 1,015 -355 660 400 0 1,060 9 11,384 -7,969 -2,000 -400 1,015 -355 660 400 0 1,060 10 11,384 -7,969 -2,000 -400 1,015 -355 660 400 1,000 2,060 -1,500 525 -975 -4,000 -600 -5,575 10. 00% -5,575 0. 0 -373 653 713 724 658 598 544 494 450 794 0 -750 350 1000 600 1 1500 -700 1000 1800 2 1500 -700 1000 1800 3 1708 -797 1000 1911 4 1708 -797 1000 1911 5 1708 -797 1000 1911 6 1708 -797 1000 1911 7 1708 -797 1000 1911 8 1708 -797 1000 1911 9 1708 -797 1000 1911 10 1708 -797 0 911 s ©2011 Pearson Education, Inc. Publishing as Prentice Hall

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