FINS1613 Lecture Notes - Lecture 7: Tax Rate, Unicycle, Kolmogorov Space

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29 May 2018

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Quiz Revision Capital Budgeting

Which of the following is a reason why incremental earnings may be different from

incremental cash flows?

(a) Changes in accounts receivable reflects non-cash sales present in incremental

earnings that are not incremental cash flows.

(b) Depreciation is a cash expense, but does not appear in incremental earnings.

depreciated over time, they should not be present in incremental cash flows.

(d) Firms pay taxes based on incremental cash flows, not incremental earnings.

(e) After-tax salvage is not important to incremental cash flows, but does factor into

revenues on the income statement.

In 2016, Project Soothsayer is expected to produce incremental earnings (after taxes and

depreciation) of $19.2 million. The expected depreciation charge in that fiscal year is $2.6

million. Expected capital expenditures total $9.0 million and after tax salvage is expected to

e $. illio. The projet’s et workig apital eeds i illios of dollars fro 5

through 2016 are given in the table below:

What are the expected cash flows from the project in 2016?

Incremental Cash Flows = 19.2 + 2.6 – 9.0 + 3.2 – (5.6 – 1.0) = 11.4

7 years ago, Knock-offs Inc. purchased a machine for $529,000 to make John Jarter action

figures. The firm produced 99,000 action figures and sold 7. Given the failure of the product,

the firm is selling off its manufacturing equipment at the end of the current fiscal year. It

will still take the depreciation charge on the current fiscal year income statement. The

machine originally had a useful life of 15 years and is being depreciated using prime cost

(straight line) depreciation. The entire book value of the asset was to be depreciated at the

end of 15 years. If it will be sold for $436,954, what is the after tax salvage value? The tax

rate is 39%.

Annual Depreciation = �,

 =,.

Book Value when selling = 529,000 – 7*35,266.67 = 282,133

Capital Gain = 436,954 - 282,133 = 154,821

Tax on Capital Gain = 154,821 * 0.39 = 60,380

After Tax Salvage Value = 436,954 – 60,380 – 376,574

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Document Summary

In 2016, project soothsayer is expected to produce incremental earnings (after taxes and depreciation) of . 2 million. The expected depreciation charge in that fiscal year is . 6 million. Expected capital expenditures total . 0 million and after tax salvage is expected to (cid:271)e . (cid:1006) (cid:373)illio(cid:374). The proje(cid:272)t"s (cid:374)et worki(cid:374)g (cid:272)apital (cid:374)eeds (cid:894)i(cid:374) (cid:373)illio(cid:374)s of dollars(cid:895) fro(cid:373) (cid:1006)(cid:1004)(cid:1005)5 through 2016 are given in the table below: Incremental cash flows = 19. 2 + 2. 6 9. 0 + 3. 2 (5. 6 1. 0) = 11. 4. 7 years ago, knock-offs inc. purchased a machine for ,000 to make john jarter action figures. The firm produced 99,000 action figures and sold 7. Given the failure of the product, the firm is selling off its manufacturing equipment at the end of the current fiscal year. It will still take the depreciation charge on the current fiscal year income statement. The machine originally had a useful life of 15 years and is being depreciated using prime cost (straight line) depreciation.

Related Questions

The following is a Financial Management problem I was assigned, and I am SO LOST! Please, can someone help me with filling in the info after the question and show me how to get the answers to fill in, and also show me how to get the answers for the 4 questions at the bottom? I'm REALLY HAVING TROUBLE understanding how to get the total cash flows, incremental cash flows, etc. THANK YOU!!!

Alliance is considering automating their production process to become more efficient. In order to do so they will buy a new monorail manufacturing system at a cost of $500,000. The system will be depreciated using seven-year MACRS (15%, 25%, 17%, 12%, 9%, 9%, 9%, 4%). The system will be sold in five years for $200,000. If they buy the system they will Trade In their current trolleys for $100,000. The trolleys were originally bought four years ago for $500,000 and are being depreciated using straight-line depreciation over five years. If Alliance does not replace the trolleys, they will be kept for the next five years when they will be sold for $10,000. The new system will not affect Allianceâs sales but will reduce Costs of Goods Sold by $1,000,000. However, Fixed Costs will rise by $50,000 per year if the monorail system is installed. The tax rate is 40% and the WACC is 10%. What are the incremental cash flows associated with this proposed project?

Balance Sheet Effects |----------Depreciation Expenses-------------|

Today Year 1 Year 2 Year 3 Year 4 Year 5 End

1. Buy New Assets

2. Trade In Old Assets

3. Keep Old Assets

4. Change in NWC

Income Statement Effects

Year 1 Year 2 Year 3 Year 4 Year 5

Net Sales

- Net COGS

- Net Depreciation

- Net Fixed Costs

= Net OEBT

- Net Taxes

= Net OEAT

+ Net Depreciation

= Net Operating CF

Total Cash Flows

CF0 =

C01 =

C02 =

C03 =

C04 =

C05 =

C06 =

Homework Questions:

1. What is the Initial Cost of this project?

A. $300,000

B. $400,000

C. $500,000

D. $600,000

2. What is net depreciation expense on the income statement in Year 1?

A. -$75,000

B. -$25,000

C. $100,000

D. $175,000

3. What is the After Tax Salvage Value of selling the equipment at the end?

A. $164,000

B. $182,000

C. $218,000

D. $236,000

4. What is the Operating Cash Flow in Year 2

A. $430,000

B. $510,000

C. $560,000

D. $620,000

Please email, text, or call me.

Thank you

Kimberly Deshotels

[email protected]

318-787-8211

orchidwildebeest290

DDK Industries is considering a new capital budgeting project that will last for three years. The initial investment outlay for project equipment is expected to be $110,000. The equipment will be straight-line depreciated down to zero book value over the three year period. The expected market value of the project assets is forecasted to be $50,000 when the project is liquidated at the end of the third year. Project will require $7,000 Net Working Capital investments in years 1 and 2. The project does not require any investment in fixed assets during years 1 and 3, but a $10,000 investment is projected in year 2. DDKâs cost of capital is 12% and the project does not have a distinct risk profile. DDKâs tax rate is 35%. Based on extensive research, analysts have prepared the following incremental revenues and before tax costs:

Year	0	1	2	3
Sales (Revenues)		100,000	100,000	100,000
- Cost of Goods Sold (50% of Sales)		50,000	50,000	50,000
Depreciation		36,667	36.667	36,667
EBIT		13,333	13,333	13,333
Capital Expenditures	-110,000	0	-10,000	0

Note: Additional fixed capital investments are depreciated straight line over a three-year period; the first depreciation expense is deducted at the end of the year following the investment. The 50,000 liquidation value reflects enhancements realized through capital investments in fixed assets.

The after tax project cash flow including the terminal cash flow for the project in year 3 is closest to ___________?

goldfrog557

Gammy is considering building a facility to manufacture cupcakes to distribute nationally. Your assignment involves both the calculation of cash flows associated with the new investment under consideration and the evaluation of several mutually exclusive projects. Grammy wants you to meet with everyone involved and write a meeting report for the board of directors that includes your recommendation. In addition to the recommendation, you have been asked to respond to a number of questions aimed at understanding the capital-budgeting process. Grammy wants to be sure that she and the board of directors understand cash flow and capital budgeting.

We are considering constructing a building to manufacture cupcakes. Currently we are in the 34 percent marginal tax bracket with a 15 percent required rate of return or cost of capital. This project is expected to last 5 years and then, because this is somewhat of a fad product, be terminated. The following information describes the project:

Cost of new plant and equipment	$7,900,000
Shipping and installation costs	$ 100,000
Unit Sales	Year Units Sold 1 70,000 2 120,000 3 140,000 4 80,000 5 60,000
Sales price per unit	$300/unit in years 1 through 4, $260/unit in year 5
Variable cost per unit	$180/unit
Annual fixed costs	$200,000 per year in years 1 â 5
Working-capital requirements	There will be an initial working-capital requirement of $100,000 just to get production started. For each year, the total investment in net working capital will be equal to 10 percent of the dollar value of sales for that year. Thus, the investment in working capital will increase during years 1 through 3, then decrease in year 4. Finally, all working capital is liquidated at the termination of the project at the end of year 5.
The depreciation method	Use the simplified straight-line method over 5 years. Assume the plant and equipment will have no salvage value after 5 years.

5. Answer the following questions:

a. Should you focus on cash flows or accounting profits in making the capital-budgeting decision? Should you be interested in incremental cash flows, incremental profits, total free cash flow, or total profits?

b. How does depreciation affect free cash flow?

c. How do sunk costs affect the determination of cash flows?

d. What is the projectâs initial outlay?

e. What are the differential cash flows over the projectâs life?

f. What is the terminal cash flow?

g. Draw a cash-flow diagram for this project.

h. What is its net present value?

i. What is its internal rate of return?

j. Should the project be accepted? Why or why not?

k. How does Genesis 47: 18 â 19 relate to this project and cash flow management?

FINS1613 Lecture Notes - Lecture 7: Tax Rate, Unicycle, Kolmogorov Space

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