Rio Grande Bookstores is considering a major expansion of its business. The deta

Question

Rio Grande Bookstores is considering a major expansion of its business. The details of the proposed expansion project are summarized below: The company will have to purchase $500,000 in equipment at t = 0. This is the depreciable cost. The project has an economic life of four years. The cost can be depreciated on a MACRS 3-year basis, which implies the following depreciation schedule: MACRS Depreciation Year Rates 1 0.33 2 0.45 3 0.15 4 0.07 At t = 0, the project requires that inventories increase by $50,000 and accounts payable increase by $10,000. The change in net operating working capital is expected to be fully recovered at t = 4. (Hint: NWC = CA-CL) The project’s salvage value at the end of four years is expected to be $0. The company forecasts that the project will generate $800,000 in sales the first two years (t = 1 and 2) and $500,000 in sales during the last two years (t = 3 and 4). Each year the project’s operating costs excluding depreciation are expected to be 60% of sales revenue. The company’s tax rate is 40%. The project’s cost of capital is 10%.

2.         What is CFFA at year 4?

a.   $150,000.

b.   $174,000.

c.   $282,000.

d.   $500,000.

2a.       What is CFFA at year 2?

a.      $282,000

b. $290,000

c. $275,000

d. $320,000

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Explanation / Answer

Rio Grande Bookstores is considering a major expansion of its business. The details of the proposed expansion project are summarized below: The company will have to purchase $500,000 in equipment at t = 0. This is the depreciable cost. The project has an economic life of four years. The cost can be depreciated on a MACRS 3-year basis, which implies the following depreciation schedule: MACRS Depreciation Year Rates 1 0.33 2 0.45 3 0.15 4 0.07 At t = 0, the project requires that inventories increase by $50,000 and accounts payable increase by $10,000. The change in net operating working capital is expected to be fully recovered at t = 4. (Hint: NWC = CA-CL) The project’s salvage value at the end of four years is expected to be $0. The company forecasts that the project will generate $800,000 in sales the first two years (t = 1 and 2) and $500,000 in sales during the last two years (t = 3 and 4). Each year the project’s operating costs excluding depreciation are expected to be 60% of sales revenue. The company’s tax rate is 40%. The project’s cost of capital is 10%.

Rio Grande Bookstores is considering a major expansion of its business. The details of the proposed expansion project are summarized below: The company will have to purchase $500,000 in equipment at t = 0. This is the depreciable cost. The project has an economic life of four years. The cost can be depreciated on a MACRS 3-year basis, which implies the following depreciation schedule: MACRS Depreciation Year Rates 1 0.33 2 0.45 3 0.15 4 0.07 At t = 0, the project requires that inventories increase by $50,000 and accounts payable increase by $10,000. The change in net operating working capital is expected to be fully recovered at t = 4. (Hint: NWC = CA-CL) The project’s salvage value at the end of four years is expected to be $0. The company forecasts that the project will generate $800,000 in sales the first two years (t = 1 and 2) and $500,000 in sales during the last two years (t = 3 and 4). Each year the project’s operating costs excluding depreciation are expected to be 60% of sales revenue. The company’s tax rate is 40%. The project’s cost of capital is 10%.

2. What is CFFA at year 4? a. $150,000. b. $174,000. c. $282,000. d. $500,000. 2a. What is CFFA at year 2? a. $282,000 b. $290,000 c. $275,000 d. $320,000 Year 1 2 3 4 Sales $800,000 $800,000 $500,000 $500,000 Less: Operating costs excluding depreciation (60% of sales revenue) -$480,000 -$480,000 -$300,000 -$300,000 Less: Depreciation ($500,000 x MACRS rate) -$165,000 -$225,000 -$75,000 -$35,000 Earnings before interest and tax $155,000 $95,000 $125,000 $165,000 Less tax @40% -$62,000 -$38,000 -$50,000 -$66,000 Earnings after tax $93,000 $57,000 $75,000 $99,000 Add: Depreciation $165,000 $225,000 $75,000 $35,000 Operating Cash Flow $258,000 $282,000 $150,000 $134,000 Net operating working capital recoverd($50,000 -$10,000) $40,000 $174,000

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