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FIN 361 Financial Management Worksheet

Part 1)

The stand-alone principle means that _____.

assets can be analyzed separately from liabilities

each firm can be evaluated independently

each project can be evaluated by itself

projects have no side effects

Part 1)

Sunk costs are costs that _____.

may change based on the NPV of the project

are due to a sunken ship

will occur in the future

have been incurred in the past and cannot be recouped fully

Part 1)

Sun Corp. uses a discount rate of 6% for below-average risk projects, 8% for average-risk projects, and 10% for above-average risk projects. Which of the following independent projects should Sun accept?

Project C has above-average risk and an IRR = 9.5%.

Project B has average risk and an IRR = 7.5%.

We need information about the projects’ NPVs to make a decision.

Project A has below-average risk and an IRR = 6.5%.

Part 2)

Which of the following items should be included in the cash flows used to estimate a project’s NPV?

All costs associated with the project that have been incurred up to now.

All costs for project-related research and development up to now.

The recovery of additional net working capital required for the project at the end of the project’s life.

Interest on bonds and loans used to finance the project.

Part 1)

What’s the most important question you should ask if you find a positive NPV project?

Why aren’t competitors doing this?

Can we expand the project?

Where does the value come from?

How much money will the company make?

Part 1)

Sensitivity analysis examines the impact of _______ on a decision criterion, such as NPV.

changing one variable

holding all variables constant

NPV sensitivity

changing several variables

Part 1)

Soft capital rationing occurs when _____.

a business cannot raise additional financing

no profitable projects can be identified

management limits the amount of investable capital

banks are not willing to make soft loan

Part 2)

Hard capital rationing occurs when _____.

management limits the amount of investable capital

a business cannot raise additional financing

banks are not willing to make hard loans

no profitable projects can be identified

Intro)

The Samsung marketing department has estimated demand for a new device and expects to sell 4 million units at a price of $270 each.

It costs $50 million each year to run the factory, independent of the level of production. Labor and components for each device add up to $170 per unit. Samsung’s marginal tax rate is 0.34, and the annual depreciation attributable to the project is $40 million.

Part 1)

What is EBIT in each year of operation (in $ million)?

Part 2)

What is the operating cash flow in each year of operation (in $ million)?

INTRO)

8 years ago, a new machine cost $5,000,000 to purchase and an additional $590,000 for the installation. The machine was to be linearly depreciated to zero over 25 years.

The company has just sold the machine for $3,000,000, and its marginal tax rate is 25%.

Part 1)

What is the annual depreciation?

Part 2)

What is the current book value?

Part 3)

What is the after-tax salvage value?

INTRO)

Southwest Airlines just bought a new jet for $32,000,000. The jet falls into the 7-year MACRS category, with the following depreciation rates (half-year convention):

Year	1	2	3	4	5	6	7	8
Depr. rate	14.29%	24.49%	17.49%	12.49%	8.93%	8.92%	8.93%	4.46%

The jet can be sold for $25,600,000 after 5 years. The company has a marginal tax rate of 34%.

Part 1)

What is the book value at the end of year 5?

Part 2)

What is the after-tax salvage value at the end of year 5?

10)

INTRO)

Your company is considering two projects and has estimated the following cash flows:

Year	Project A	Project B
0	-15,000	-20,000
1	10,000	10,000
2	10,000	16,000

Part 1)

If project B expands your manufacturing capacity by building a separate factory, what is the relevant cash flow for evaluating project B in year 2?

Part 2)

If project B replaces an existing factory (project A), what is the relevant cash flow for evaluating project B in year 2?

Part 3)

If project B replaces an existing factory (project A), what is the relevant cash flow for evaluating project B in year 0?

11)

INTRO)

Better Tires Corp. is planning to buy a new tire making machine for $50,000 that would save it $100,000 per year in production costs. The savings would be constant over the project’s 3-year life. The machine is to be linearly depreciated to zero and will have no resale value after 3 years.

The appropriate cost of capital for this project is 16% and the tax rate is 21%

Part 1)

What is the cash flow from assets in each year of operation (years 1 to 3)?

Part 2)

What is the NPV of this project?

12)

INTRO)

Part 1)

What is net capital spending in year 0, i.e., at the start of the project (in $ million)?

Part 2)

What is the cash flow from assets in year 0 (in $ million)?

Part 3)

What is the cash flow from assets in year 1 (in $ million)?

Part 4)

What is the annual depreciation in year 2 (in $ million)?

Part 5)

What is the cash flow from assets in year 2 (in $ million)?

Part 6)

What is the after-tax salvage value of the factory in year 11 (in $ million)?

Part 7)

What is the cash flow from assets in year 11 (in $ million)?

Part 8)

What is the NPV of this project (in $ million)?

13)

INTRO)

Your company makes and sells shaving cream. You’re thinking of replacing one of your packaging machines. Both the new and the old machine would last another 5 years. Your annual sales will remain constant at $43,000.

The old machine could be sold for $5,000 today or $2,000 in 5 years, after taxes. The annual cost of running the machine is $30,000 and its annual depreciation expense is $2,000.

The new machine costs $29,000 today and could be sold for $5,800, after taxes, in 5 years. The annual cost of running the machine is $14,000 and its annual depreciation expense is $5,800. The new machine doesn’t require any additional net working capital.

Your marginal tax rate is 34% and the cost of capital for this project is 10%. Your task is to find out if you should replace the machine.

Part 1)

What would be the incremental cash flow from assets in year 0 if you replaced the machine?

Part 2)

What would be the cash flow from assets in each of the first 4 years if you kept the old machine?

Part 3)

What would be the free cash flow in each of the first 4 years if you bought the new machine?

Part 4)

What would be the cash flow from assets in year 5 if you kept the old machine?

Part 5)

What would be the cash flow from assets in year 5 if you bought the new machine?

Part 6)

What is the NPV of the replacement project?

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