(Determining relevant cash flows) Landcruisers Plus (LP) has operated an online
ID: 2787224 • Letter: #
Question
(Determining relevant cash flows) Landcruisers Plus (LP) has operated an online retail store selling off-road truck parts. As the name implies, the firm specializes in parts for the venerable Toyota FJ40 that is known throughout the world for its durability and offroad prowess. The fact that Toyota stopped building and exporting the FJ40 to the U.S. market in 1982 meant that FJ40 owners depended more and more on re-manufactured parts to keep their beloved off-road vehicles running. More and more FJ40 owners are replacing the original inline six-cylinder engines with a modern American-built engine. The engine replacement requires mating the new engine with the Toyota drive train P's owners had been offering engine adaptor kits for some time but have recently decided to begin building their own units. To make the adaptor kits the firm would need to invest in a variety of machine tools costing a total of $750,000 LP's management estimates that they wil be able to borrow $360,000 from the firm's bank and pay 8 percent interest. The remaining funds would have to be supplied by LP's owners The firm estimates that they wil be able to sell ,000 units a year for $1,400 each. The units would cost $1,000 each in cash expenses to produce (this does not include depreciation expense of $75,000 per year or interest expense of S28,800). After all expenses, the firm expects earnings before interest and taxes of $325,000. The firm pays taxes equal to 32 percent, which results in net income of $192,200 per year over the 10-year expected life of the equipment. a. What is the annual free cash flow LP should expect to receive from the investment in year 1 assuming that it does not require any other investments in either capital equipment or working capital and the equipment is deprecated over a 10-year life to a zero salvage and book valuc? How should the financing cost associated with the $360,000 loan be incorporated into the analysis of cash flow? b. If the firm's required rate of return for its investments is 14 porcent and the investment has a 10-year expected life, what is the anticipated NPV of the investment? a. The financing cost associated with the $360,000 loan should not be incorporated into the analysis of cash flow. (Select from the drop-down menu.) The annual free cash flow LP should expect to receive from the investment in years 1 through 10 is Round to the nearest dollar.)Explanation / Answer
. Free cash flows = Net income + non cash expenses (i.e., depreciation)
= 192,200 + 75,000 = $267,200
The finance of $360,000 is done at an interest rate of 8% which is paid to other external agencies and the interest expenses on such finance will be deducted from the earnings.
b. Computation of NPV of the investment:
Year
1
2
3
4
5
6
7
8
9
10
Revenue
1,400,000
1,400,000
1,400,000
1,400,000
1,400,000
1,400,000
1,400,000
1,400,000
1,400,000
1,400,000
Less: cost
(1,000,000)
(1,000,000)
(1,000,000)
(1,000,000)
(1,000,000)
(1,000,000)
(1,000,000)
(1,000,000)
(1,000,000)
(1,000,000)
Less: interest on loan
(28,800)
(28,800)
(28,800)
(28,800)
(28,800)
(28,800)
(28,800)
(28,800)
(28,800)
(28,800)
Less: depreciation
(75,000)
(75,000)
(75,000)
(75,000)
(75,000)
(75,000)
(75,000)
(75,000)
(75,000)
(75,000)
Earnings before tax
296,200
296,200
296,200
296,200
296,200
296,200
296,200
296,200
296,200
296,200
Less: tax 32%
(94,784)
(94,784)
(94,784)
(94,784)
(94,784)
(94,784)
(94,784)
(94,784)
(94,784)
(94,784)
Earnings after tax
201,416
201,416
201,416
201,416
201,416
201,416
201,416
201,416
201,416
201,416
Add: Depreciation
75,000
75,000
75,000
75,000
75,000
75,000
75,000
75,000
75,000
75,000
Cash flows
276,416
276,416
276,416
276,416
276,416
276,416
276,416
276,416
276,416
276,416
Discounting factor at 14%
0.8772
0.7695
0.6750
0.5921
0.5194
0.4556
0.3996
0.3506
0.3075
0.2697
Present value of cash flows
242,470
212,693
186,573
163,660
143,562
125,931
110,466
96,900
85,000
74,562
NPV = sum of all Present value of cash flows = $1,441,818
Year
1
2
3
4
5
6
7
8
9
10
Revenue
1,400,000
1,400,000
1,400,000
1,400,000
1,400,000
1,400,000
1,400,000
1,400,000
1,400,000
1,400,000
Less: cost
(1,000,000)
(1,000,000)
(1,000,000)
(1,000,000)
(1,000,000)
(1,000,000)
(1,000,000)
(1,000,000)
(1,000,000)
(1,000,000)
Less: interest on loan
(28,800)
(28,800)
(28,800)
(28,800)
(28,800)
(28,800)
(28,800)
(28,800)
(28,800)
(28,800)
Less: depreciation
(75,000)
(75,000)
(75,000)
(75,000)
(75,000)
(75,000)
(75,000)
(75,000)
(75,000)
(75,000)
Earnings before tax
296,200
296,200
296,200
296,200
296,200
296,200
296,200
296,200
296,200
296,200
Less: tax 32%
(94,784)
(94,784)
(94,784)
(94,784)
(94,784)
(94,784)
(94,784)
(94,784)
(94,784)
(94,784)
Earnings after tax
201,416
201,416
201,416
201,416
201,416
201,416
201,416
201,416
201,416
201,416
Add: Depreciation
75,000
75,000
75,000
75,000
75,000
75,000
75,000
75,000
75,000
75,000
Cash flows
276,416
276,416
276,416
276,416
276,416
276,416
276,416
276,416
276,416
276,416
Discounting factor at 14%
0.8772
0.7695
0.6750
0.5921
0.5194
0.4556
0.3996
0.3506
0.3075
0.2697
Present value of cash flows
242,470
212,693
186,573
163,660
143,562
125,931
110,466
96,900
85,000
74,562
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