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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
2.
a.
NWC
b.
3.
$1,500
+ $1,000
$2,000
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.
b.
c.
10.
Year
UCC
CCA (5%)
$1,000,000
$25,000
$975,000
975,000
48,750
926,250
926,250
46,313
879,937
879,937
43,997
835,940
835,940
41,797
794,143
794,143
39,707
754,436
Operating cash flows of the project for the next six years (figures in thousands of
dollars).
Year:
Capital Investment
Revenues
-1,000
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%
22.75
22.75
22.75
22.75
22.75
22.75
Operating Cash
Flow (excluding
CCA Tax Shield)
42.25
Operating
Expenses:
42.25
42.25
42.25
42.25
42.25
17.063
16.209
15.399
14.629
13.898
51.000
59.313
58.459
57.649
56.879
56.148
(CCA x 35%)
Total Cash Flow
-1,000
13.
20.
a.
The year-wise CCA for the new grill, over its expected life, is as follows:
End of year
UCC
Year
UCC
CCA (30%)
$20,000
$3,000
17,000
5,100
11,900
11,900
3,570
8,330
$17,000
Operating cash flow contribution, excluding tax shields, for year 1 through 3
= Saving in energy expenses x (1 - .35) = $10,000 x (1 - .35) = $6,500. Now,
we must consider the effect of the CCA tax shield on the projects yearly cash
flows.
Year:
b.
6,500
6,500
6,500
1,050
1,785
1,250
7,550
8,285
7,750
[=7,750 + 5,000]
c.
First, we compute present value of cash flows excluding the CCA tax shield:
PV = -20,000 + 6,500 x annuity factor(12%, 3 years) + 5,000 x discount factor
(12%, 3 years) = -$829.3.
We next calculate the present value of the CCA tax shield:
PV of CCA tax shield:
=
r + d 1 + r d + r (1 + r ) t
0.12 + 0.3
0.3 + 0.12
(1 + 0.12 ) 3
1 + 0.12
= $3,842.41
NPV = Total PV excluding CCA tax shields + PV of CCA tax shield
= -$829.3 + $3, 842.41 = -$3,013.11
21.
a.
b.
CCA for the first 5 years of the plant and equipments life is as follows:
Year
UCC
CCA (25%)
End of year
UCC
$50,000
$6,250
$43,750
43,750
10,938
32,812
32,812
8,203
24,609
24,609
6,152
18,457
18,457
4,614
13,843
Sales
40
30
20
10
Expenses
16
12
24
18
12
-tax @ 40%
9.6
7.2
4.8
2.4
14.4
10.8
7.2
3.6
For calculating project cash flows for each year, we will need to calculate the
tax savings generated from the CCA tax shield. We do this by multiplying
each years CCA by the firms tax rate (40% in this case).
(in thousands of dollars)
Year:
Capital investment
-50.00
- 8.00
2.0
2.0
2.0
2.0
14.4
10.8
7.2
3.6
16.4
12.8
9.2
5.6
2.5
4.4
3.3
2.5
18.9
17.2
12.5
8.1
c.
- 58.00
The project NPV is calculated in two phases. First, we calculate the present
value from cash flows excluding the CCA tax shield:
Year:
(58)
16.40
12.80
9.20
5.60
1.000
0.909
0.826
0.751
0.683
(58)
14.91
10.57
6.91
3.83
* Notice, you could also calculate this as follows, keeping in mind that there
could be some difference of result due to rounding errors.
58 +
16 .4
12 .8
9 .2
5 .6
+
+
+
1 .1
(1.1) 2
(1.1) 3
(1.1) 4
, where S = 0
r + d 1 + r d + r (1 + r ) t
0.10 + 0.25
=
1 + 0.10
= $13,636
NPV (in thousands of dollars) = Total PV excluding CCA tax shields + PV of
CCA tax shield
= -$21.78 + $13.64 = -$8.14
Solutions to Chapter 9
3.
a.
b.
4.
a.
b.
Fixed costs can increase until the point at which the higher costs (after taxes) reduce NPV
by $2 million.
Increase in fixed costs (1 T) annuity factor(12%, 10 years) = $2 million
c.
5.
b.
c.
d.
Base Case
Best Case
Worst Case
Price
$ 50
55
45
Variable Cost
$ 30
27
33
Fixed Cost
$300,000
270,000
330,000
Sales
$ 30,000
33,000
27,000
a.
b.
DOL = 1 +
a.
b.
c.
28.
DOL is higher when profits are lower because a $1 change in sales leads to a
greater percentage change in profits.
a.
Price
Sales units
Variable cost
Optimistic
Pessimistic
$ 60
$ 55
50,000
30,000
$30
$ 30
b.
If the project can be abandoned after 1 year, then it will be sold for $5.4 million. (There
will be no taxes, since this also is the depreciated value of the equipment.) Cash flow at t =
1 equals CF from project plus sales price:
$697,500 + $5,400,000 = $6,097,500
PV = = $5,444,196
NPV in the abandonment scenario is:
$5,444,196 $6,000,000 = $555,804
which is not as disastrous as the result in part (a).
Expected NPV is now positive:
$695,514 + ($555,804) = $69,855
Because of the abandonment option, the project is now worth pursuing.