Appendix A Solutions to Self-Test Questions and Problems A-15

CHAPTER 12

ST-2 a. Estimated investment requirements:

Price ($55,000)
Installation (10,000)
Change in net operating working capital (2,000)
Total investment ($67,000)
b. Depreciation schedule:
Equipment cost  $65,000; MACRS 3-year class
YEARS
1 2 3
MACRS depreciation rates 33% 45% 15%
Equipment depreciation expense $21,450 $29,250 $9,750
Note that the remaining book value of the equipment at the end of the project’s life
is 0.07  $65,000  $4,550.
c. Terminal cash flow:
Salvage value $10,000
Tax on salvage valuea (2,180)
Net operating working capital recovery 2,000
Termination cash flow $ 9,820
a Sales price $10,000
Less book value 4,550
Taxable income $ 5,450
Tax at 40% $ 2,180
Book value  Depreciable basis  Accumulated depreciation
 $65,000  $60,450  $4,550
d. Net operating cash flows:
Year 1 Year 2 Year 3
Revenues (4,000  $50) $200,000 $200,000 $200,000
Variable costs (70%) 140,000 140,000 140,000
Fixed costs 30,000 30,000 30,000
Depreciation 21,450 29,250 9,750
EBIT $ 8,550 $ 750 $ 20,250
Taxes (40%) 3,420 300 8,100
NOPAT $ 5,130 $ 450 $ 12,150
Add back: Depreciation 21,450 29,250 9,750
Operating cash flow $ 26,580 $ 29,700 $ 21,900
e. Project cash flows:
0 11% 1 2 3

Operating cash flows 67,000 26,580 29,700 21,900

Terminal cash flow 9,820
Project cash flows 67,000 26,580 29,700 31,720
f. From the time line shown in part e, the project’s NPV can be calculated as follows:
NPV  $67,000  $26,580/(1.11)1  $29,700/(1.11)2  $31,720/(1.11)3
 $4,245
Alternatively, using a financial calculator, you would enter the following data: CF0
 67000; CF1  26580; CF2  29700; CF3  31720; I/YR  11; and then solve for
NPV  $4,245.
Since the NPV is positive, the project should be accepted.
g. Project analysis if unit sales turned out to be 20 percent below forecast:
Initial projection  4,000 units; however, if unit sales turn out to be only 80 percent
of forecast then unit sales  3,200.
A-16 Appendix A Solutions to Self-Test Questions and Problems

Year 0 Year 1 Year 2 Year 3

Equipment purchase $65,000

Change in NOWC 2,000
Revenues (3,200  $50) $160,000 $160,000 $160,000
Variable costs (70%) 112,000 112,000 112,000
Fixed costs 30,000 30,000 30,000
Depreciation 21,450 29,250 9,750
EBIT $ 3,450 $ 11,250 $ 8,250
Taxes (40%) 1,380 4,500 3,300
NOPAT $ 2,070 $ 6,750 $ 4,950
Add back: Depreciation 21,450 29,250 9,750
Operating cash flow $67,000 $ 19,380 $ 22,500 $ 14,700
Terminal cash flow 9,820
Project cash flows $67,000 $ 19,380 $ 22,500 $ 24,520

Project NPV:
0 11% 1 2 3

67‚000 19‚380 22‚500 24‚520

NPV  $67,000  $19,380/(1.11)1  $22,500/(1.11)2  $24,520/(1.11)3

 $13,350
Alternatively, using a financial calculator, you would enter the following data: CF0
 67000; CF1  19380; CF2  22500; CF3  24520; I/YR  11; and then solve for
NPV  $13,350.
Since the NPV is negative, the project should not be accepted. If unit sales were
20 percent below the forecasted level, the project would no longer be accepted.
h. Best-case scenario: Unit sales  4,800, Variable cost %  65%.

Year 0 Year 1 Year 2 Year 3

Equipment purchase $65,000

Change in NOWC 2,000
Revenues (4,800  $50) $240,000 $240,000 $240,000
Variable costs (65%) 156,000 156,000 156,000
Fixed costs 30,000 30,000 30,000
Depreciation 21,450 29,250 9,750
EBIT $ 32,550 $ 24,750 $ 44,250
Taxes (40%) 13,020 9,900 17,700
NOPAT $ 19,530 $ 14,850 $ 26,550
Add back: Depreciation 21,450 29,250 9,750
Operating cash flows $67,000 $ 40,980 $ 44,100 $ 36,300
Terminal cash flow 9,820
Project cash flows $67,000 $ 40,980 $ 44,100 $ 46,120

Project NPV:

0 11% 1 2 3

67‚000 40‚980 44‚100 46‚120

NPV  $67,000  $40,980/(1.11)1  $44,100/(1.11)2  $46,120/(1.11)3

 $39,434
Alternatively, using a financial calculator, you would enter the following data:
CF0  67000; CF1  40980; CF2  44100; CF3  46120; I/YR  11; and then solve
for NPV  $39,434.
Base-case scenario: The NPV was calculated in part f as $4,245.
Worst-case scenario: Unit sales  3,200; Variable cost %  75%.