ASSIGNMENT 5

Complete all questions. Late submissions incur loss of marks. No

assignments accepted on day of class.

1. Complete 1 & 3 on page 333

The MacCauley Company has sales of $200 million and total expenses (excluding
depreciation) of $130 million. Straight-line depreciation on the company’s assets is $15
million, and the maximum accelerated depreciation allowed by law is $25 mil-lion.
Assume that all taxable income is taxed at 40 percent. Assume also that net working
capital remains constant. a. Calculate the MacCauley Company’s after-tax operating
cash flow using both straight-line and accelerated depreciation.
b. Assuming that the company uses straight-line depreciation for book purposes and
accelerated depreciation for tax purposes, show the income statement reported to the
stockholders. What is the after-tax operating cash flow under these circumstances
1. a. Straight Line Depreciation:
200 -130= 70 mill [Earnings before interest and depreciation]
70-15= 55 mill [Earnings Before Tax]
55 * (1-40%)
33 million [After-tax Operating Cash flow]

b. Accelerated Depreciation
200 -130= 70 mill [Earnings before interest and depreciation]
70-25=45 mill [Earnings Before Tax]
45 * (1-40%)
27 million [After-tax Operating Cash flow]

Depreciation = 25 million
Operating Cash flow = 27 million + 25 million
Operating Cash flow = 52 million

3. a. Projects A, B D, E, and G should be adopted because the rate of return is greater

than or equal to the required rate of return.

b. A capital budgeting funds constraint would push firms to select the best projects
with high rates of return, so the ones who have low rates of return like Project E
would less likely be chosen.

c. The riskier the project, the more valuable it will be. the expected project return
would have to be compared to the risk-adjusted required rate of return.
2. Complete 6 on page 334
The Jacob Chemical Company is considering building a new potassium sulfate plant. The
following cash outlays are required to complete the plant:
Year 0 1 2
Cash Outlay $4,000,000 2,000,000 500,000
Jacob’s cost of capital is 12 percent, and its marginal tax rate is 40 percent.
a. Calculate the plant’s net investment (NINV)

a. Net investment = 4,000,000 + 2,000,000/1.12 + 500,000/1.12^2

= $5,521,706.45

b. Installed cost of the plant = 5,521,706.45 x (1-.4) = $3,313,023.87

3. Complete 1 on page 372

1. Calculate the net present value and profitability index of a project with a net investment of
$20,000 and expected net cash inflows of $3,000 a year for 10 years if the project’s required
return is 12 percent. Is the project acceptable?

NPV =(3000 x 5.650) -20000 Net Cash Inflow x (PVAFr,n) - net investment

16950-20000

-3050

Profitability Index = 16950/20000=.848 = NPV / Net investment

The company NPV is negative and profitability index is less than 1, so it is in the
company best interest to turn down the project.

4. Complete 2 on page 373

a. NINV= 300,000 + 75,000 = 375,000
= 80,000 + 75,000 + 100,000 (1-.4) = 215,000
NPV= 80,000(PVIFA12, 9) + 215,000(PVIF12,10) -375,000
= 80,000(5.328) + 215,000(0.322) - 375,000
= 120,470

b. The project is acceptable, because its NPV is positive

c. The project will generate a return that is higher than the cost of capital and
the value would of increase by 120,470.

d. = 18.71%

e. The net present value calculation assumes the net cash flows are reinvested
at 12%, the project’s required return. The project’s calculate IRR is 18.71%
which means the reinvestment rate under IRR is 18.71%.
 Question 5
Two mutually exclusive investment projects have the following
forecasted cash flows:

Year A B
0 -20,000 -20,000
1 7000 0
2 7000 0
3 7000 0
4 7000 32,625

A. Compute the net present value for each project if the firm has a 10%
cost of capital
Project A = -20,000 + 7000/1.10^1 + 7000/1.10^2 + 7000/1.10^3 + 7000/1.10^4
= -20,000 + 6363.64 + 5785.12+ 5259.20 + 4781.09
= 2,189.05
Project B = -20,000 + 0 + 0 +0 + 32,625/1.10^4
= - 20,000 + 22,283.31
= 2,283.31

B. Compute the internal rate of return for each project at 10%.

Project A = 15% [ excel snippet below]
-20000
7000
7000
7000
7000
15%
 Project B = % [ excel snippet below]
-20000
0
0
0
32625
13%

C. Which project should be adopted? Why?

Project A should be adopted because the IRR is greater. The higher the rate of return, the more
desirable the investment is.