Corporate Finance (10th) Ross, Stephen A.; Ross, Stephen; Westerfield, Randolph;

Question

Corporate Finance (10th) Ross, Stephen A.; Ross, Stephen; Westerfield, Randolph; Jaffe, Jeffrey F.; Jaffe, Jeffrey ISBN: 0078034779 ISBN13: 9780078034770

Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.94 million. The fixed asset falls into the three-year MACRS class. The project is estimated to generate $2,160,000 in annual sales, with costs of $839,000. The project requires an initial investment in net working capital of $380,000, and the fixed asset will have a market value of $250,000 at the end of the project.

Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.94 million. The fixed asset falls into the three-year MACRS class. The project is estimated to generate $2,160,000 in annual sales, with costs of $839,000. The project requires an initial investment in net working capital of $380,000, and the fixed asset will have a market value of $250,000 at the end of the project.

If the tax rate is 34 percent and the required return is 10 percent, what is the project’s Year 1 net cash flow? Year 2? Year 3? (Use MACRS) (Enter your answers in dollars, not millions of dollars, i.e. 1,234,567. Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))

Explanation / Answer

First of all we have to calculate annual depreciation for the equipment as follows:

So the book value at the end of threee years will be initial investment minus accumulated depreciation, is

Book value in 3 year = $2940,000 -$2722,146 = $217,854

The asset is sold at gain to book value, so this gain is taxable.

After tax slavage value =$250,000 +(($217,854-$250,000) *.34) = $239,070

OCF will be calculated as per tax shield approach.

OCF = (Sales- Cost) (1-t) +Tax * Depreciation

$ Year 1 depreciation =$2940,000*0.3333=     979,902 Year 2 depreciation =$2940,000*0.4445= 1,306,830 Year 3 depreciation =$2940,000*0.1481=     435,414 2,722,146

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