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1.

**Net income = ($74 − 42 − 10) − .35 × ($74 − 42 − 10) = $22 − $7.7 = $14.3 million
**

•

Revenues − cash expenses − taxes paid = $74 − $42 − $7.7 = $24.3 million

•

Net Profit + Deprec = $14.3 + $10 = $24.3 million

•

**(Revenues − cash expenses) × (1 − T) + T × Deprec
**

= $32 × .65 + .35 × $10 = $24.3 million

2.

a.

∆ NWC

**= ∆ Acct Receivable + ∆ Inventory − ∆ Acct Payable
**

=

b.

3.

−$1,500

+ $1,000

− $2,000

Cash flow = $36,000 − $24,000 + $2,500 = $14,500

**Net income = ($7 − 4 − 1) − .40 × ($7 − 4 − 1) = $2 − $0.8 = $1.2 million
**

•

Revenues − cash expenses − taxes paid = $3 − $0.8 = $2.2 million

•

Net Profit + Deprec = $1.2 + $1.0 = $2.2 million

•

**(Revenues − cash expenses) × (1 − T) + T × Deprec
**

= $3 × .60 + .40 × $1 = $2.2 million

6.

7.

= −$2,500

Revenue

$160,000

Rental costs

35,000

Variable costs

45,000

Depreciation

10,000

Pretax profit

70,000

Taxes (35%)

24,500

Net income

$45,500

a.

Net Profit + Depreciation = $45,500 + $10,000 = $55,500

b.

**Revenue – rental costs – variable costs – taxes
**

= $160,000 – $35,000 – $45,000 – $24,500

= $55,500

25 Operating Expenses: 42.250 46.35 × (Depreciation) = ($160.75 22.313 879.500 10.000.25 .25 42.000 $975.25 42.000.000 120 120 120 120 120 120 Direct production costs 40 40 40 40 40 40 Fixed maintenance costs 15 15 15 15 15 15 Pre-tax Profits 65 65 65 65 65 65 Tax @35% 22. (Revenue – rental costs – variable costs) × (1–.c.35 × $10.940 5 835.797 794.500 = $55.75 22.000 $25. Capital investment: $1.000) × .65 + .75 22.436 Operating cash flows of the project for the next six years (figures in thousands of dollars).937 43. Year: Capital Investment Revenues 0 1 2 3 4 5 6 -1.000 = $52.000 + $3.25 42.707 754.250 3 926.000 2 975.75 22.940 41.25 42.75 Operating Cash Flow (excluding CCA Tax Shield) 42.000 – $35.143 6 794.997 835.35) + .75 22.937 4 879.000 CCA calculation: End of Year UCC Year UCC CCA (5%) 1 $1.000 48.143 39.000 – $45.750 926.

75 17.785 1. Now.250 Total Operating Cash Flow 7.459 57.000. the grill is sold for $5. At the end of year 3. total cash flows are: Time 0 1 2 3 Cash Flows ($) -20.550 8. Year: b.900 3. we must consider the effect of the CCA tax shield on the project’s yearly cash flows.500 6.000 $3.000 59.148 (CCA x 35%) Total Cash Flow -1.550 8.2 = 1.050 1.000 x (1 .209 15.629 13.. 1 2 3 Contribution from saving in energy expenses 6.570 8.5 million 20.500 CCA Tax Shield (CCA x .CCA Tax Shield 8.35) = $6. Therefore.000 Operating cash flow contribution.900 3 11.898 51.000 13.000 2 17.500 6.399 14.649 56. The year-wise CCA for the new grill. a.750 [=7.063 16.000] . over its expected life. the CF from the investment is -$20.879 56.750 + 5.000 5.35) = $10.330 $17.000. is as follows: End of year UCC Year UCC CCA (30%) 1 $20.100 11..285 12.5 – ∆ NWC ∆ NWC = $0. excluding tax shields.750 Total Cash Flow (0-3) = Operating CF + CF associated with investments.500.285 7.35) 1.000 7. for year 1 through 3 = Saving in energy expenses x (1 . At time 0.313 58.2 + . Cash flow = Net income + depreciation – increase in NWC 1.

35 1 + ( 0. we compute present value of cash flows excluding the CCA tax shield: PV = -20. CCA for the first 5 years of the plant and equipment’s life is as follows: Year UCC CCA (25%) End of year UCC 1 $50.938 32.000 x discount factor (12%.000) = $58.609 4 24.000 + 6.609 6.812 3 32. 3 years) + 5.3 + $3.12 = = $3.013.35 1 − × 0.000 for working capital (20% of 40. 3 years) = -$829.500 x annuity factor(12%.750 10.3 × 0.41 NPV = Total PV excluding CCA tax shields + PV of CCA tax shield = -$829. We next calculate the present value of the CCA tax shield: PV of CCA tax shield: = CdTc 1 + 0.41 = -$3.12 ) 3 1 + 0.750 2 43.5r SdTc 1 − × r + d 1 + r d + r (1 + r ) t 20000 × 0.5 × 0.12 ) 5000 × 0. First.3.843 (In thousands of dollars) Year: 0 1 2 3 4 5 Sales 40 30 20 10 0 Expenses 16 12 8 4 0 = Profit before tax 24 18 12 6 0 .614 13.3 0.12 (1 + 0.c.3 × 0.11 21.152 18. a.000 $6. Initial investment = $50.000 b. 842.203 24.250 $43.457 4.457 5 18.3 + 0.000 + $8.12 + 0.812 8.842.

8 2.751 0. .000 0.00 The project NPV is calculated in two phases.909 0.2 5.1 Decrease in working capital from previous year 5 Operating Cash Flow (excluding CCA tax shield) Total Cash Flow .5 4.00 Initial investment in working capital .4 10.20 5.0 2.0 2.5 8.2 3.40 12. we calculate the present value from cash flows excluding the CCA tax shield: Year: 0 1 2 3 4 Total Cash Flow (excluding CCA tax shield) (58) 16.2 4.60 x Discount Factor (10%) 1.58.8 7. First.826 0.8.80 9.5 18.4 12. we will need to calculate the tax savings generated from the CCA tax shield.8 7. (in thousands of dollars) Year: 0 Capital investment -50.9 17.683 .3 2.8 9.-tax @ 40% 9.6 7.58.40) Total c.2 12.2 3.4 0 = Operating Cash Flow (excl.0 14.00 (excluding CCA tax shield) CCA tax shield (CCA x 0.00 1 2 3 4 2.6 0 For calculating project cash flows for each year. CCA tax shield) 14.4 10.6 16.0 2.4 3. We do this by multiplying each year’s CCA by the firm’s tax rate (40% in this case).6 2.

5r SdTc 1 − × .5 ×0.325 million × 5. Increase in fixed costs × (1 – T) × annuity factor(12%. 10-year annuity factor is 5. 4.PV of total cash flow (excl.636 NPV (in thousands of dollars) = Total PV excluding CCA tax shields + PV of CCA tax shield = -$21.650. keeping in mind that there could be some difference of result due to rounding errors.65 million.14 Solutions to Chapter 9 3.25 = 1 + 0.65 million × 5.836 million increase $.673 million decrease b.83 Total PV (excl.64 = -$8.1) 3 (1.650 a.5 million × (1 – . − 58 + 16 . CCA tax shield) (21. (Revenue – expenses) changes by $1 million – $0.91 10.91 3.57 6.650 = $1. b. 10 years) = $2 million .10 = $13.35) = $0. After-tax profits increase by $0.78) * Notice. Expenses increase from $5 million to $6 million.25 ×0. After-tax income and CF fall by $1 million × (1 – . Fixed costs can increase until the point at which the higher costs (after taxes) reduce NPV by $2 million.4 12 .2 5 .6 + + + 1 .325 million. $.78 + $13.4 1 + ( 0.1) 4 We next calculate the present value of the CCA tax shield: PV of CCA tax shield = CdTc 1 + 0.35) = $0.8 9 .10 ) −0 0.5 million = $0.1) 2 (1. cash flow changes by an equal amount.5 million. CCA tax shield)* (58) 14. The 12%. a. you could also calculate this as follows. where S = 0 r + d 1 + r d + r (1 + r ) t 50000 × 0. So the effect on NPV equals the change in CF × 5.650 = $3.10 + 0. Because depreciation is unaffected.1 (1.

2 million) + . Pretax profits are currently $(10 – 5 –2) = $3 million.605 = $6. If variable cost = $1.4 × $1 million = $3.1 million b. 5.5 million) + . Then Revenue = P × 6 million Expense = $1 × 6 million + $2 million = $8 million .08 million × 3.95 million. c.4 × $1 million = $2.08 million NPV = –$5 million + $2. then expenses increase to $1.Increase × (1 – .2 million d.2 million.20.8 million × 3.60 × ($12 million – $7. 12%) = –$5 million + $2.588 Accounting profits currently are $(10 – 5 – 2) million × (1 – .8 million a.35) × 5.605 = $2. NPV = –$5 million + $2.60 × ($12 million – $9.1 million NPV = –$5 million + $3.5 million c.650 = $2 million Increase = $544.5 million = $7.605 = $5.1 million × 3.35) = $1.4 × $1 million = $2. CF = . If fixed costs = $1. expenses fall to ($1 × 6 million) + $1.5 million.60 × ($12 million – $8 million) + .8 million × annuity factor(5 years. Fixed costs can increase by this amount ($ 3 million) before pretax profits are reduced to zero.5 million CF = . Revenue = Price × quantity = $2 × 6 million = $12 million Expense = Variable cost + fixed cost = $1 × 6 million + $2 million = $8 million Depreciation = $5 million/5 years = $1 million per year CF = (1 − T) × (Revenue – expenses) + T × depreciation = .20 × 6 million + $2 million = $9. Call P the price per jar.

000 33.000 CF = (1 – T) × [Revenue – Cash Expenses] + T × Depreciation Depreciation = $1 million/10 years = $100.2161 × $ 31. b. Cash flow equals (1 – .65 [27.65 [33.928 Worst-case NPV = 5.100 10-Year Annuity factor at 14% discount rate = 5.000) + .40) × (6P – 8) + . Base Case Best Case Worst Case Price $ 50 55 45 Variable Cost $ 30 27 33 Fixed Cost $300. Therefore. Each dollar of sales generates $0.000 = –$ 837.2161 × $460.571 The firm must sell 4.000 + 100.4) × 3.100 – $1.2161 Best-case NPV = 5.286 diamonds annually.40 × 1 = 3.399.4 NPV = –5 + (3.70 of pretax profit.000.35 × 100.000. 10-year annuity factor is 5.000 The 12%.000 per year Best-case CF = . Call Q the number of diamonds sold.000 = $1.650 = $1.100 – $1.605 = –20.000 Sales $ 30.862 + 12.000 270.000.000 330.000] + .35)(Revenue – expenses) + .000) × 5.35 (100.6P – 4.35 × depreciation = .5Q – 95.000 = $ 31.61 per jar 6.650.70 = $428.000 and fixed costs are $200.000 . for NPV to equal zero.000)/.779 9. 35 × 100. (45. Accounting break-even revenues are therefore: (200.65 (100Q – 30Q – 200.000 × (55 – 27) – 270.100 Worst-case CF = .075Q – 536.750 = 1.000 = $460.CF = (1 – .000] + . Depreciation is $100.6P – 4.000) = 45.5Q – 95.000.000 27. a.000.978P NPV = 0 when P = $1.000 × (45 – 33) – 330.000 257.

10 years) = –$2.000 – $7.978 diamonds per year 19.058.000] + . DOL = 1 + a.35 × 600. Price Sales units Variable cost Optimistic Pessimistic $ 60 $ 55 50.985.058.000 $30 $ 30 CF = (1 – T) × (Revenue – Cash Expenses) + T × Depreciation Optimistic CF = .5) Expected NPV = × $695. Profit = Revenues – variable cost – fixed cost – depreciation = $10.35 × 600.78 c.185.185.500 – $1.000 × annuity factor(12%.000 + 1.000 NPV = –6.000 – $1.65 [ (55 – 30) × 30.514 + × (−$2.500 NPV = –6.000 – $600 = $400 DOL = 1 + = 5.000 30.500 × annuity factor(12%.000.000 – $600 = $900 DOL = 1 + = 2.000 = $1.000] + .969) = –$681.728 The firm will reject the project.969 (using annuity tables. .000 – $6.65 × [(60 – 30) × 50.0 b. a. DOL is higher when profits are lower because a $1 change in sales leads to a greater percentage change in profits.000 + 697. 10 years) = $ 695.000.Q = 5. Profit = Revenues – variable cost – fixed cost – depreciation = $ 8. we will get $695. we will get -$2.487) Pessimistic CF = .000 = $ 697.058. 28.514 (using annuity tables.

000.b. If the project can be abandoned after 1 year.) Cash flow at t = 1 equals CF from project plus sales price: $697.196 – $6.400.855 Because of the abandonment option. then it will be sold for $5.000 = –$555. (There will be no taxes.500 PV = = $5. Expected NPV is now positive: × $695.804) = $69.444.444.500 + $5.514 + × (−$555.097. since this also is the depreciated value of the equipment.196 NPV in the abandonment scenario is: $5. the project is now worth pursuing. .804 which is not as disastrous as the result in part (a).4 million.000 = $6.

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