FIN-3030, Final Exam, F17, Zaidi you want to start a dry cleaning business. You
ID: 2799763 • Letter: F
Question
FIN-3030, Final Exam, F17, Zaidi you want to start a dry cleaning business. You project the following relevant necessary equipment to start this business Questions 18-20: Suppose assumptions for this business: It will cost you $150,000 in investment to purchase the The equipment will last 10 years and can be depreciated to zero on a straight-line basis You expect this business to last 10 years and believe you can generate $100,000 in revenue per year . Y * You expect your tax rate to be 40%; " At the end of the 10 years you believe the salvage value of your equipment will be $15,000 ou expect your costs will be $65,000 per year, not including depreciation, · You believe the appropriate discount rate for this project is 15%. Your simple, partial, pro-forma income statement for this project can be summarized as follows In $ per year Revenue Costs Depreciation EBIT Taxes Net Income 100,000 65,000 18) What is the annual operating cash flow (OCF) from the project? a) b) c) d) 10,000k oCF s 20,000 20,000Explanation / Answer
Revenue
$ 100,000
Less: Expenses
$ 65,000
Less: Depreciation
$ 15,000
EBIT
$ 20,000
Less: Tax @ 40 %
$ 8,000
Net Income
$ 12,000
18)
Annual operating cash flow = Net Income + Depreciation = $ 12,000 + $ 15,000 = $ 27,000
Hence option “b) 20,000 <OFC 30,000” is correct answer.
19)
Year
Cash Flow
Formula for PV Factor
PV Factor @ 10%
PV
0
$ (150,000)
1/(1+0.15)^0
1
$ (150,000.00)
1
$ 15,000
1/(1+0.15)^1
0.869565217
$ 13,043.48
2
$ 15,000
1/(1+0.15)^2
0.756143667
$ 11,342.16
3
$ 15,000
1/(1+0.15)^3
0.657516232
$ 9,862.74
4
$ 15,000
1/(1+0.15)^4
0.571753246
$ 8,576.30
5
$ 15,000
1/(1+0.15)^5
0.497176735
$ 7,457.65
6
$ 15,000
1/(1+0.15)^6
0.432327596
$ 6,484.91
7
$ 15,000
1/(1+0.15)^7
0.37593704
$ 5,639.06
8
$ 15,000
1/(1+0.15)^8
0.326901774
$ 4,903.53
9
$ 15,000
1/(1+0.15)^9
0.284262412
$ 4,263.94
10
$ 24,000
1/(1+0.15)^10
0.247184706
$ 5,932.43
NPV
$ (72,493.81)
If OFC is $ 15,000 NPV will be $ (72,493.81)
Hence option “d) NPV - 70,000” is correct answer.
20)
Let’s decrease the discount rate and observe the change of NPV.
Year
Cash Flow
Formula for PV Factor
PV Factor @ 9 %
PV
0
$ (150,000)
1/(1+0.09)^0
1
$ (150,000.00)
1
$ 15,000
1/(1+0.09)^1
0.917431193
$ 13,761.47
2
$ 15,000
1/(1+0.09)^2
0.841679993
$ 12,625.20
3
$ 15,000
1/(1+0.09)^3
0.77218348
$ 11,582.75
4
$ 15,000
1/(1+0.09)^4
0.708425211
$ 10,626.38
5
$ 15,000
1/(1+0.09)^5
0.649931386
$ 9,748.97
6
$ 15,000
1/(1+0.09)^6
0.596267327
$ 8,944.01
7
$ 15,000
1/(1+0.09)^7
0.547034245
$ 8,205.51
8
$ 15,000
1/(1+0.09)^8
0.50186628
$ 7,527.99
9
$ 15,000
1/(1+0.09)^9
0.46042778
$ 6,906.42
10
$ 24,000
1/(1+0.09)^10
0.422410807
$ 10,137.86
NPV
$ (49,933.44)
NPV has increased than NPV for discount at 10%.
If we further decrease the discount rate, we can get a positive NPV
Year
Cash Flow
Formula for PV Factor
PV Factor @ 1 %
PV
0
$ (150,000)
1/(1+0.01)^0
1
$ (150,000.00)
1
$ 15,000
1/(1+0.01)^1
0.99009901
$ 14,851.49
2
$ 15,000
1/(1+0.01)^2
0.980296049
$ 14,704.44
3
$ 15,000
1/(1+0.01)^3
0.970590148
$ 14,558.85
4
$ 15,000
1/(1+0.01)^4
0.960980344
$ 14,414.71
5
$ 15,000
1/(1+0.01)^5
0.951465688
$ 14,271.99
6
$ 15,000
1/(1+0.01)^6
0.942045235
$ 14,130.68
7
$ 15,000
1/(1+0.01)^7
0.932718055
$ 13,990.77
8
$ 15,000
1/(1+0.01)^8
0.923483222
$ 13,852.25
9
$ 15,000
1/(1+0.01)^9
0.914339824
$ 13,715.10
10
$ 24,000
1/(1+0.01)^10
0.905286955
$ 21,726.89
NPV
$ 217.15
Hence option “a) NPV will increase in value” is correct answer.
Revenue
$ 100,000
Less: Expenses
$ 65,000
Less: Depreciation
$ 15,000
EBIT
$ 20,000
Less: Tax @ 40 %
$ 8,000
Net Income
$ 12,000
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