12-1

a. Equipment
NOWC Investment
Initial investment outlay

$ 9,000,000
3,000,000
$12,000,000

b. No, last years $50,000 expenditure is considered a sunk cost and does not represent an
incremental cash flow. Hence, it should not be included in the analysis.
c. The potential sale of the building represents an opportunity cost of conducting the project in that
building. Therefore, the possible after-tax sale price must be charged against the project as a cost.
12-2

a. Operating cash flows: t = 1

Sales revenues
Operating costs
Depreciation
Operating income before taxes
Taxes (40%)
Operating income after taxes
Add back depreciation
Operating cash flow

$10,000,000
7,000,000
2,000,000
$ 1,000,000
400,000
$ 600,000
2,000,000
$ 2,600,000

b. The cannibalization of existing sales needs to be considered in this analysis on an after-tax

basis, because the cannibalized sales represent sales revenue the firm would realize without
the new project but would lose if the new project is accepted. Thus, the after-tax effect would
be to reduce the firms operating cash flow by $1,000,000(1 T) = $1,000,000(0.6) = $600,000.
Thus, the firms OCF would now be $2,000,000 rather than $2,600,000.
c. If the tax rate fell to 30%, the operating cash flow would change to:
Operating income before taxes
Taxes (30%)
Operating income after taxes
Add back depreciation
Operating cash flow

$1,000,000
300,000
$ 700,000
2,000,000
$2,700,000

Thus, the firms operating cash flow would increase by $100,000.

12-3

Equipments original cost

Depreciation (80%)
Book value

$20,000,000
16,000,000
$ 4,000,000

Gain on sale = $5,000,000 $4,000,000 = $1,000,000.

Tax on gain = $1,000,000(0.4) = $400,000.
AT net salvage value = $5,000,000 $400,000 = $4,600,000.