FIN-3030, Final Exam, F17, Zaid Questions 18-20: Suppose assumptions for this bu

Question

FIN-3030, Final Exam, F17, Zaid Questions 18-20: Suppose assumptions for this business: you want to start a dry cleaning business. You project the following relevant It will cost you $150,000 in investment to purchase the necessary equipment to start this business 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 You expect your costs will be $65,000 per year, not including depreciation 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 · 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 20,000

Explanation / Answer

Depreciation = 150,000 / 10 = 15,000

Net Income = 12,000

OCF = Net Income + Depreciation = 27,000

NPV can be calculated using PV function on a calculator

N = 10, PMT = 27,000, FV = 15,000 x (1 - 40%), I/Y = 15% => Compute PV = $137,731

NPV = 137,731 - 150,000 = -$12,269

If discount rate declines, NPV increases.

18 - b, 19 - c, 20 - a

Revenues 100,000 Costs 65,000 Depreciation 15,000 EBIT 20,000 Tax 8,000 Net Income 12,000 OCF 27,000 NPV -$12,268.58

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