Solutions to Capital Budgeting Problems

Capital Budgeting Handout
3 Expansion Problems
Ellis Construction Company
T = 0 Initial Investment
Buy and modify equipment

(60,000)

Change in NWC

(2,000)

Total Initial Investment

(62,000)

T = 1-3 Operations
Inc. EBIT
Depreciation
Taxable Income
NOPAT
+ Depreciation
CF from Operations

Year 1
20,000
(19,800)
200
120
19,800
19,920

Year 2
20,000
(27,000)
(7,000)
(4,200)
27,000
22,800

Year 3
20,000
(9000)
11,000
6,600
9,000
15,600

T = 3 Termination
Sell the equipment

20,000
(6,320)

MV = 20,000
BV = 4,200
Gain 15,800
*T
*.40
(6,320)
Reverse the Change in NWC

2,000

Total Cash Flow from Termination
15,680
NOTE: The depreciation amounts are from the MACRS 3-yr schedule [ yr. 1 = 33%, Yr.
2 = 45%, Yr. 3 = 15%, Yr. 4 = 7%] multiplied by the depreciable cost of the equipment.
Timeline
Year
0
1
2
3
CF
(62,000)
19,920
22,800
15,600
15,680
TOTAL
(62,000)
19,920
22,800
31,280

8) 53.8) 53.000) T = 1-3 Operations Inc.333) (1.333 51.999.333].333 51.62 years Discounted Payback Period = never pays back on a discounted basis.333) (3.000 (53.000 Gain 50.000 (53.333 51.08% Payback Period = 2.333) (3.81) IRR = 8.000 Total Cash Flow from Termination 48.000 (53.333) (1.000 (20.999. _____________________________________________________________ 2nd Capital Budgeting Problem T = 0 Initial investment Buy and modify equipment Change in Net working Capital (170.000 divided by 3 = 53.333) (3.000 – 10.000 *T *.000) MV = 60.68% MIRR = 9. EBIT Depreciation Taxable Income NOPAT + Depreciation CF from Operations Year 1 50.000) Total Initial Investment (178.333) (1.000 NOTE: The depreciation amounts are from using the straight line method and depreciating over three years toward a 10.999.000) Reverse the Change in NWC 8.000) (8.NPV = (1546.333 Year 3 50.8) 53.333 Year 2 50. .333 T = 3 Termination Sell the equipment 60.000 BV = 10.40 (20.000 salvage value [170.

4 = 7%] multiplied by the depreciable cost of the equipment. Yr.235 2. 2 = 45%.87% MIRR = 7.225) (6.000 (39. .76 years Discounted Payback Period = never pays back on a discounted basis 3rd Capital Budgeting Problem .185 T = 3 Termination Sell the equipment 65.500 Total Cash Flow from Termination 51.333 TOTAL (178.925 17.541.075 35.795 39. Yr.765) 4.333 NPV = (20.000 (18. EBIT Depreciation Taxable Income NOPAT + Depreciation CF from Operations Year 1 44. Yr.748) 54.110 18.333 51. 3 = 15%.000) T = 1-3 Operations Inc.000) 51.34) IRR = 5.565 *T *.333 48.765 42560 Year 2 44.075) 25.000) 1 51.000 BV = 8.232 Reverse the Change in NWC 5.477 Year 3 44.268 NOTE: The depreciation amounts are from the MACRS 3-yr schedule [ yr.333 2 51.500) Total Initial Investment (126.225) (10.000 (54.000 (19.000 99.51% Payback Period = 2. 1 = 33%.34 19.500) (5.232) MV = 65.435 Gain 56.225 47.Brauer T = 0 Initial investment Buy and modify equipment Change in Net working Capital (120.333 3 51.Timeline Year CF 0 (178.

000 (160) MV = 3000 BV = 2600 Gain = 400 *T *.250 2.560 2 47.660) T = 1-6 Operations Sales increase Cost decrease Change in EBIT [line 1-2] Change in Depreciation Taxable Income [line 3-4] NOPAT + Depreciation CF from Operations 1 1.134 610 1.82 years Replacement Problems Dauten Toy T= 0 Initial Investment Buy the new machine (8.968 1.Timeline Year CF 0 (126.500) 2.250 2.500) 2.330 1.500 2 1.170 1.500) 2.000) Change in NWC (1.28% Payback Period = 2.500) Sell the old machine 3.4 Tax 160 Total Initial Investment _______ (6.477 3 35.000 (1.560 47.383.370 750 1.210 2.500 3 1.182 530 1.170 610 530 130 1.250 290 1.500 5 1.185 51.000 174 2.268 86.384 798 1.500 1.500 4 1.000) 42.500) 2.000 (1.58% MIRR = 15.500 6 1.000 (1.210 1.712 1.83 IRR = 16.500) 2.422 130 1.477 TOTAL (126.970 2.000 (1.000 (1.500) 2.890 1.000 (1.453 NPV = 11.000) 1 42.552 .744 1.42 years Discounted Payback Period = 2.

744 1.4 Tax 320 500 MV = 500 BV = 500 Gain = 0 no tax due Rev.000 *T *.18 years Discounted Payback Period = 4.980 Net Salvage CF OLD 500 Difference 1980 – 500 = 1480 = the improved salvage value of the new over the old.060) 6 1.552 1480 3032 .000 2.712 NPV = 1334.56% Payback Period = 3.000 (20.34 Tax 20.660) 1 2.000) Change in NWC 1.T=6 Termination Net Salvage Cash Flow NEW Net Salvage Cash Flow OLD Sell the new Sell the old 800 (320) MV = 800 BV = 0 Gain = 800 *T *. Change NWC Net Salvage CF New 1.000 BV = 6.968 1.384 1.744 5 1.968 4 1.060 Total Initial Investment __________ (104.000 Gain 59. Timeline Year CF 0 (6.660) 2.000 Sell the old 65.89 IRR = 22.500 1.03% MIRR = 18.000 2 2.712 TOTAL (6.97 years Yonan T=O Initial Investment Buy the new (150.060) MV = 65.384 3 1.

T = 1-5 Operations Change in EBIT Change in Depreciation Taxable Income [line 1-2] NOPAT + Depreciation CF from Operations 1 50.000 24.610 T = 5 Termination Net Salvage Cash Flow NEW Net Salvage Cash Flow OLD Sell the new Sell the old 0 3060 MV = 0 BV = 9.000 (3.190 28.160 24.540) = the loss of salvage value of the new over the old.500 42.120 Payback Period = 2.320 42.120 22.000 *T *.000 33.000 *T * .000 41.400) MV = 10. Timeline Year CF 0 (104.000 48.060 Credit Rev.400 (1.000) 2.060) 1 41.000 49.600 = (4.500 4 50.600 Difference 2.120 TOTAL (104.540) 34.120 18.000 28.060 Net Salvage CF OLD 6.160 2 49.500 26.000 18.070 .34 Tax 3.500 17.060 – 6.320 48.21 years NPV = 33.320 14. 53% MIRR = 22.34 Tax 3.690 4 39.000 21.252.690 21.000 16.000 BV = 0 Gain = 10.610 (4. Change NWC Net Salvage CF New 10.000 2.32 years Discounted Payback Period = 3.000 39.000 5 50.320 3 42.000 2 50.160 49.61% 5 38.03 IRR = 29.110 16.000 3 50.500 32.690 39.160 1.500 38.060) 41.000 Loss = 9.

000 27.200 T=8 Termination Net Salvage Cash Flow NEW Net Salvage Cash Flow OLD Sell the new Sell the old 0 0 MV = 0 BV = 0 Gain =0 no tax due Rev.000) Sell the old machine 30.000 27.4 tax 400 3.230 16.500) Change in NWC (3.Baton Rouge T= 0 Initial Investment Buy the new machine (82. .075 4.950 0 0 16.500 20.755 13.595 10.200 16.900 12.000 (6.500 Gain = 15.000 *T _*.000 27.400 24.100 17.000 – 600 = 2.000 27.100 14.000 27.000 Net Salvage CF OLD 600 Difference 3.925 22.325 17.4 Tax 6.950 0 0 20.000 27.270 20.500 20.660 8.700) T = 1-8 Operations Change in EBIT Change in Depreciation Taxable Income [line 3-4] NOPAT + Depreciation CF from Operations 1 2 3 4 5 6 7 8 27.200 Total Initial Investment _______ (61.075 4.000 27.000 27.560 21.000 10.675 9.000 9.830 18.400 = the improved salvage value of the new over the old.000 3.900 12.500 *T *.200 16.180 16.900 9.675 9.200) MV = 30. Change NWC Net Salvage CF New 1.900 9.000 BV = 0 Gain = 1.260 10.000 BV = 14.000 (400) MV = 1.500 6.050 27.200 10.900 3.160 19.

160 5 19.560 21.000 5 255.445 .000 Loss 335.000) 151. (61.000 3 255.250 4 255.000 2 255.175.000 BV = 600.Timeline Year CF 0 (61.000 256.000 *T *.400 (660) 256.68 years NPV = 39.12% McCullough T=O Initial Investment Buy the new (1.000 115.200 8 16.160 19.250 171.700) 1 20.700) 20.250 140.180 16.000 255.000 9.000 175.400 24.48% MIRR = 19.200 TOT.000 (1.000 103.34 Tax 113.270 20.830 18.340 100.440 21.600 Payback Period = 2.000 113.900 Total Initial Investment __________ (796.000 21.750 92.195 9.750 234.440 162.400 2 24.79 years Discounted Payback Period = 3.000 207.200 2.250 203.155 103.100) T = 1-5 Operations Change in EBIT Change in Depreciation Taxable Income [line 1-2] NOPAT + Depreciation CF from Operations T = 5 Termination 1 255.560 3 21.900 MV = 265.270 4 20.000 245.400 18.180 7 16.347.400 115.830 6 18.000) Change in NWC 0 Sell the old 265.405 154.89 IRR = 29.

0 = 119.91 years NPV = 14.095.000 (25.330) 0 MV = 0 BV = 0 Gain = 0 No tax due 0 119.39% 5 171.440 TOTAL (796. Timeline Year CF 0 (796.670 .670 Net Salvage CF OLD 0 Difference 119.100) 1 207.670 291.405 175.340 3 203.7% MIRR = 12.000 BV = 70.34 Tax 25. Change NWC Net Salvage CF New 145.340 203.500 Gain = 74.100) 207.48 IRR = 12.330 Rev.400 2 255.500 *T *.440 Payback Period = 3.115 .400 255.Net Salvage Cash Flow NEW Net Salvage Cash Flow OLD Sell the new Sell the old MV = 145.405 4 175.74 years Discounted Payback Period = 4.445 119.670 = the increased salvage value of the new over the old.