Chapter 10 review 4-1-08

1.) A proposed new investment has projected sales of $740,000. Variable costs are 60
percent of sales, and fixed costs are $173,000; depreciation is $75,000. Prepare a pro
forma income statement assuming a tax rate of 35 percent. What is the projected net
income?
Sales 740,000
Costs – 444,000
Fixed – 173,000
Depreciation – 75,000
EBIT = 48,000
Taxes – 16,800
Net Income = 31,200
2.) Consider the following income statement:
Sales $876,400
Costs $547,300
Depreciation $128,000
EBIT 201,100
Taxes (34%) 68,374
Net Income 132,726
Fill in the missing numbers and then calculate the OCF. What is the depreciation tax
shield?
201,100 + 128,000 – 68,374 = 260,726 OCF
Tax Shield = OCF = (Sales – Costs) x (1 – T) + Depreciation x T
128,000 x .34 = 43,520

3.) A proposed new project has projected sales of $96,000, costs of $49,000, and
depreciation of $4,500. The tax rate is 35 percent. Calculate operating cash flow
using the four different approaches described in the chapter and verify that the answer
is the same in each case.
OCF = EBIT + Depreciation – Taxes – regular way
OCF = Net income + Depreciation – bottom-up approach
OCF = Sales – Costs – Taxes – top-down approach
OCF= (Sales – Costs) x (1-T) + Depreciation x T- tax shield approach
OCF = $32,125
4.) A piece of newly purchased industrial equipment costs $925,000 and is classified as
seven-year property under MACRS. Calculate the annual depreciation allowances
and end-of-the-year book values for this equipment.
Year 8 allowance = $41,162

5.) Phone Home, Inc., is considering a new three-year expansion project that requires an
initial fixed asset investment of $4.2 million. The fixed asset will be depreciated
straight-line to zero over its three-year tax life, after which time it will be worthless.
The project is estimated to generate $3,100,000 in annual sales, with costs of
$990,000. If the tax rate is 35 percent, what is the OCF for this project?
4,200,000 / 3 = 1,400,000 depreciation per year
3,100,000 – 990,000 – 1,400,000 = EBIT 710,000 – Taxes 248,500 = Net Income 461,500
OCF = 710,000 + 1,400,000 – 248,500 = 1,861,500

6.) In the previous problem, suppose the required return on the project is 12 percent.
What is the project’s NPV?

Year 0 Year 1 Year 2 Year 3

Operating cash flow 1,861,500 1,861,500 1,861,500
Change in NWC
Capital spending -4,200,000 0
Total cash flow -4,200,000 1,861,500 1,861,500 1,861,500

NPV = 271,008.91