Chapter 11

Chapter11
CapitalBudgetingCashFlows
Instructors Resources
Overview
Thischapterexpandsuponthecapitalbudgetingtechniquespresentedinthelastchapter(Chapter10).
Shareholderwealthmaximizationreliesuponselectionofprojectsthathavepositivenetpresentvalues.
Themostimportantanddifficultaspectofthecapitalbudgetingprocessisdevelopinggoodestimatesof
therelevantcashflows.Chapter11focusesonthebasicsofdeterminingrelevantaftertaxcashflowsofa
project,fromtheinitialcashoutlaytoannualcashstreamofcostsandbenefitsandterminalcashflow.It
alsodescribesthespecialconcernsfacingcapitalbudgetingforthemultinationalcompany.Thetext
highlightshowcapitalbudgetingwillbeacriticalaspectoftheprofessionallifeandpersonallifeof
studentsupongraduation.
Suggested Answer to Opener in Review Question
Chapter11CapitalBudgetingCashFlows221
ThechapteropenertalkedaboutExxonMobilsconsiderableinvestmentinlongtermprojectsand
thesometimesdifficulttaskofhavingprojectscomeinonbudget.Howareprojectcashflows
affectedbybudgetoverruns?Inthecapitalbudgetingprocess,howshouldfinancialmanagers
accountforthepotentialofbudgetoverruns?
Itiscriticaltohavethebestestimateofprojectcashflowspossiblewhenmakingaprojectaccept/reject
decision.Dependinguponthescopeofaproject,financialmanagersmayneedtodrawinformationfrom
manyareasofacorporationincludingresearchanddevelopment,marketing,operations,humanresources,
andwithinthevariousdepartmentsdealingwithcorporatefinance.Itmaybepossibletogetsomeofthe
informationdirectlyfromtheprojectmanagersiftheyhavedonesomeofthelegworkalready.
Budgetoverrunsmeanhigherthanexpectedcosts,andthereforelowerthanexpectedcashflows.Lower
thanexpectedcashflowsmeanlowerthanexpectedcapitalbudgetingoutcomes(e.g.,lowerNPVs,PIs,
IRRs,etc.).Iffinancialmanagersdonotadequatelyaccountforpossiblebudgetoverrunsinthecapital
budgetingprocesstheyareunlikelytofullymaximizefirmvalue.Chapter12considerstheuncertaintyof
cashflowsinmoredetailanddiscussessomeofthemethodsusedbyfinancialmanagerstoaccountfor
theuncertaintyofcashflows.Inparticular,ExxonMobilcouldgeneratearangeordistributionofcapital
budgetingoutcomesforprojectsthathaveuncertaincashflowsduetopossiblebudgetoverruns.ExxonMobil
shouldcalculateNPVsusingcashflowsthatassumenobudgetoverrunandavarietyofpossiblebudget
overrunsandthencalculateanexpectedaverageNPVwheretheweightsreflecttheprobablyofeach
budgetoutcome.
2012PearsonEducation,Inc.PublishingasPrenticeHall
223Gitman/ZutterPrinciplesofManagerialFinance,Thirteenth Edition
Answers to Review Questions

1. Capitalbudgetingprojectsshouldbeevaluatedusingincrementalaftertaxcashflows,sinceaftertax
cashflowsarewhatisavailabletothefirm.Whenevaluatingaproject,concernisplacedonlyon
addedcashflowsexpectedtoresultfromitsimplementation.Expansiondecisionscanbetreated
asreplacementdecisionsinwhichallcashflowsfromtheoldassetsarezero.Bothexpansionand
replacementdecisionsinvolvepurchasingnewassets.Replacementdecisionsaremorecomplex
becauseincrementalcashflowsresultingfromthereplacementmustbedetermined.
2. Thethreecomponentsofcashflowforanyprojectare(1)initialinvestment,(2)operatingcashflows,
and(3)terminalcashflows.
3. Sunkcostsarecoststhathavealreadybeenincurredandthusthemoneyhasalreadybeenspent.
Opportunitycostsarecashflowsthatcouldberealizedfromthenextbestalternativeuseofanowned
asset.Sunkcostsarenotrelevanttotheinvestmentdecisionbecausetheyarenotincremental.These
costswillnotchangenomatterwhatthefinalaccept/rejectdecision.Opportunitycostsarearelevant
cost.Thesecashflowscouldberealizedifthedecisionismadenottochangethecurrentasset
structurebuttoutilizetheownedassetforthisalternativepurpose.
4. Tominimizelongtermcurrencyrisk,companiescanfinanceaforeigninvestmentinlocalcapital
marketssothattheprojectsrevenuesandcostsareinthelocalcurrencyratherthandollars.
Techniquessuchascurrencyfutures,forwards,andoptionsmarketinstrumentsprotectagainstshort
termcurrencyrisk.Financialandoperatingstrategiesthatreducepoliticalriskincludestructuringthe
investmentasajointventurewithacompetentandwellconnectedlocalpartner,andusingdebt
ratherthanequityfinancing,sincedebtservicepaymentsarelegallyenforceableclaimswhileequity
returnssuchasdividendsarenot.
5.
a.
Thecostofthenewassetisthepurchaseprice.(Outflow)
b. Installationcostsareanyaddedcostsnecessarytogetanassetintooperation.(Outflow)
c. Proceedsfromsaleofoldassetarecashinflowsresultingfromthesaleofanexistingasset,
reducedbyanyremovalcosts.(Inflow)
d. Taxonsaleofoldassetisincurredwhenthereplacedassetissoldduetorecaptureddepreciation,
capitalgain,orcapitalloss.(Maybeaninfloworanoutflow)
e. Thechangeinnetworkingcapitalisthedifferencebetweenthechangeincurrentassetsandthe
changeincurrentliabilities.(Maybeaninfloworanoutflow)
6. Thebookvalueofanassetisitsstrictaccountingvalue.
Bookvalueinstalledcostofassetaccumulateddepreciation
Gainsandlossesinthesaleofanassetmayhavetaxconsequences,andhencearebothkeyformsof
taxableincome.Morespecifically,taxableincomemayarisefrom(1)capitalgain:portionofsale
priceaboveinitialpurchaseprice,taxedattheordinaryrate;(2)recaptureddepreciation:portionof
salepriceinexcessofbookvaluethatrepresentsarecoveryofpreviouslytakendepreciation,taxedat
theordinaryrate;and(3)lossonthesaleofanasset:amountbywhichsalepriceislessthanbook
value,taxedattheordinaryrateanddeductedfromordinaryincomeiftheassetisdepreciableand
usedinbusiness.Iftheassetisnotdepreciableorisnotusedinbusiness,itisalsotaxedatthe
ordinaryratebutisdeductibleonlyagainstcapitalgains.
7. Theassetmaybesold(1)formorethanitsbookvalue,(2)fortheamountofitsbookvalue,or
(3)atapricebelowbookvalue.Inthefirstcase,taxesarisefromtheamountbywhichthesaleprice
exceededthebookvalue.Inthesecondcase,notaxeswouldberequired.Inthethirdcase,atax
creditwouldoccur.
8. Thedepreciablevalueofanassetistheinstalledcostofanewassetandisbasedonthedepreciable
costofthenewproject,includinginstallationcost.
9. Depreciationisusedtodecreasethefirmstotaltaxliabilityandthenisaddedbacktonetprofitsafter
taxestodeterminecashflow.Table11.6andEquation3.4(refertothetext)areequivalentwaysof
expressingoperatingcashflows.TheearningsbeforeinterestandtaxesinTable11.6isthesameas
theEBITterminologyinEquation3.4.Bothmodelsthentakeouttaxesandaddbackindepreciation.
10. Tocalculateincrementaloperatingcashinflowforboththeexistingsituationandtheproposed
project,thedepreciationonassetsisaddedbacktotheaftertaxprofitstogetthecashflows
associatedwitheachalternative.Thedifferencebetweenthecashflowsoftheproposedandpresent
situation,theincrementalaftertaxcashflows,aretherelevantoperatingcashflowsusedin
evaluatingtheproposedproject.
11. Theterminalcashflowisthecashflowresultingfromterminationandliquidationofaprojectatthe
endofitseconomiclife.Theformofcalculatingterminalcashflowsisshownbelow:
TerminalCashFlowCalculation:
Aftertax
proceedsfrom
saleofnewasset
Aftertax
proceedsfrom
saleofoldasset
Proceedsfrom
saleofoldasset
Taxonsaleof
oldasset
Changein
networking
capital
Termina
lcash
flow
ExtendedPresentation:
Proceedsfrom
saleofnewasset
Taxonsaleof
newasset
Changein
networking
capital
Termina
lcash
flow
12. Therelevantcashflowsnecessaryforaconventionalcapitalbudgetingprojectaretheincremental
aftertaxcashflowsattributabletotheproposedproject:theinitialinvestment,theoperatingcash
inflows,andtheterminalcashflow.Theinitialinvestmentistheinitialoutlayrequired,takinginto
accounttheinstalledcostofthenewasset,proceedsfromthesaleoftheoldasset,taxonthesaleof
theoldasset,andanychangeinnetworkingcapital.Theoperatingcashinflowsaretheadditional
cashflowsreceivedasaresultofimplementingaproposal.Terminalcashflowrepresentstheafter
taxcashflowsexpectedtoresultfromtheliquidationoftheprojectattheendofitslife.Thesethree
componentsrepresentthepositiveornegativecashflowimpactifthefirmimplementstheproject,
andaredepictedinthefollowingdiagramforaprojectlasting5years.
Suggested Answer to Global Focus Box:

Changes May Influence Future Investments in China
AlthoughChinahasbeenactivelycampaigningforforeigninvestment,howdoyouthinkhaving
acommunistgovernmentaffectsitsforeigninvestment?
Havingacommunistgovernmenthasanegativeaffectonforeigndirectinvestment(FDI).Asinall
investmentsabroad,FDIinChinaentailshightravelandcommunicationsexpenses.Thedifferencesof
politicalsystemandculturethatexistbetweenthecountryoftheinvestorandthehostcountrywillalso
causeproblemswithforeigndirectinvestmentinChina.Duetoitscontroloftheeconomy,thecommunist
partyhasmorecontroloveremployment,rawmaterials,andrepatriationofrevenuestoaparentfirmthan
foundinnoncommunistcountries.Thereisalsothechancethatacompanymayloseownershipofits
overseasoperationstoaChinesecompany.Hence,foreignfirmsoftenpartnerwithChinesefirmsintheir
developmentefforts,butthisrequirescoordinationandraisesthecostsofFDIinChina.
Suggested Answer to Focus on Ethics Box:

A Question of Accuracy
Whatwouldyouroptionsbewhenfacedwiththedemandsofanimperialchiefexecutiveofficer
(CEO)whoexpectsyoutomakeitwork?Brainstormseveraloptions.
ThereisachancethatyoumaybeworkingforanimperialCEOatsomepointinyourcareer.Thismay
bebychoiceorbychance.Whilethemakeitworkmandatemayseemlikeanordertodoanythingit
takestoaccomplishyourjob,youareundernoobligationtodoanythingunethicalorillegal.Ifthatisthe
onlywaytoaccomplishthejob,thebestapproachistoaskyoursuperiordirectly,Is(this)whatyouwant
metodo?
Iftheansweristhatyoushouldbreakthelawordosomethingunethical,youmayhavethreeviableoptions
otherthandoingsomethingthatyoushouldnotdo.Oneoptionistoseektheguidanceofyourmentorif
youhaveoneinthecompany.Heorshemaybeabletointerveneonyourbehalf.Anotheroptionistotake
thematteroveryourbossshead(inthecaseofaCEO,thatwouldbetheboardofdirectors).Thethird
optionistoevaluateyourcareeroptions.Youmaybebetterservedworkingelsewhere.Realistically,by
offeringoppositiontoanimperialCEO,youmaybelimitingyourcareerinyourpresentcompany.
However,donotimmediatelyassumethatdowhateverittakesormakeitworkautomaticallyincludes
anythingunethicalorillegal.TheCEOmayjustbestatingthatmoreresourcesoreffortneedtobeputinto
solvingtheproblem.
Answers to Warm-Up Exercises

E111.
Categorizingafirmsexpenditures
Answer: Inthiscase,thetuitionreimbursementshouldbecategorizedasacapitalexpendituresincethe
outlayoffundsisexpectedtoproducebenefitsoveraperiodoftimegreaterthan1year.
E112.
Classificationofprojectcostsandcashflows
Answer: $3.5billionalreadyspentsunkcost(irrelevant)
$350millionincrementalcashoutflowrelevantcashflow
$15millionperyearcashinflowrelevantcashflow
$450millionforsatellitesopportunitycostandrelevantcashflow
E113.
Findingtheinitialinvestment
Answer: $20,000Purchasepriceofnewmachinery
$3,000Installationcosts
$4,500Aftertaxproceedsfromsaleofoldmachinery
$18,500Initialinvestment
E114.
Bookvalueandrecaptureddepreciation
Answer: Bookvalue$175,000$124,250$50,750
Recaptureddepreciation$110,000$50,750$59,250
E115.
Initialinvestment
Answer: Initialinvestmentpurchasepriceinstallationcostsaftertaxproceedsfromsaleofold
assetchangeinnetworkingcapital
$55,000$7,500$23,750$2,000$40,750
Solutions to Problems
Note:TheMACRSdepreciationpercentagesusedinthefollowingproblemsappearinChapter4,
Table4.2.Thepercentagesareroundedtothenearestintegerforeaseincalculation.
Forsimplification,5yearlivedprojectswith5yearsofcashinflowsaretypicallyusedthroughoutthis
chapter.Projectswithusablelivesequaltothenumberofyearsofcashinflowsarealsoincludedinthe
endofchapterproblems.ItisimportanttorecallfromChapter4thatundertheTaxReformActof1986,
MACRSdepreciationresultsinn1yearsofdepreciationforannyearclassasset.Thismeansthatin
actualpracticeprojectswilltypicallyhaveatleastoneyearofcashflowbeyondtheirrecoveryperiod.
P111. Classificationofexpenditures
LG2;Basic
a.
Operatingexpenditureleaseexpireswithinoneyear
b.
Capitalexpenditurepatentrightsexistformanyyears
c.
Capitalexpenditureresearchanddevelopmentbenefitslastmanyyears
d.
Operatingexpendituremarketablesecuritiesmatureinunderoneyear
e.
Capitalexpendituremachinewilllastoveroneyear
f.
Capitalexpenditurebuildingtoolwilllastoveroneyear
g.
Capitalexpenditurebuildingwilllastformorethanoneyear
h.
Operatingexpendituremarketchangesrequireobtaininganotherreportwithinayear
P112. Relevantcashflowandtimelinedepiction
LG1,2;Intermediate
a.
Year
Cash Flow
Thisisaconventionalcashflowpattern,wherethecashinflowsareofequalsize,whichisreferredto
asanannuity.
b.
Thisisaconventionalcashflowpattern,wherethesubsequentcashinflowsvary,whichisreferredto
asamixedstream.
c.
Thisisanonconventionalcashflowpattern,whichhasseveralcashflowseriesofequalsize,whichis
referredtoasanembeddedannuity.
P113. Expansionversusreplacementcashflows
LG3;Intermediate
a.
Year
RelevantCashFlows
Initialinvestment
b.
($28,000)
1
4,000
6,000
8,000
10,000
4,000
Anexpansionprojectissimplyareplacementdecisioninwhichallcashflowsfromtheold
assetarezero.
P114. Sunkcostsandopportunitycosts
LG2;Basic
a.
The$1,000,000developmentcostsshouldnotbeconsideredpartofthedecisiontogoahead
withthenewproduction.Thismoneyhasalreadybeenspentandcannotberetrievedsoitisa
sunkcost.
b.
The$250,000salepriceoftheexistinglineisanopportunitycost.IfMastersGolfProducts
doesnotproceedwiththenewlineofclubstheywillnotreceivethe$250,000.
c.
P115. Sunkcostsandopportunitycosts
LG2;Intermediate
a.
SunkcostThefundsforthetoolinghadalreadybeenexpendedandwouldnotchange,no
matterwhetherthenewtechnologywouldbeacquiredornot.
b.
OpportunitycostThedevelopmentofthecomputerprogramscanbedonewithout
additionalexpendituresonthecomputers;however,thelossofthecashinflowfromthe
leasingarrangementwouldbealostopportunitytothefirm.
c.
OpportunitycostCovolwillnothavetospendanyfundsforfloorspacebutthelostcash
inflowfromtherentwouldbeacosttothefirm.
d.
SunkcostThemoneyforthestoragefacilityhasalreadybeenspent,andnomatterwhat
decisionthecompanymakesthereisnoincrementalcashflowgeneratedorlostfromthe
storagebuilding.
e.
OpportunitycostForgoingthesaleofthecranecoststhefirm$180,000ofpotentialcash
inflows.
P116. Personalfinance:Sunkandopportunitycashflows
LG2;Intermediate
a.
Thesunkcostsorcashoutlaysareexpendituresthathavebeenmadeinthepastandhaveno
effectonthecashflowsrelevanttoacurrentsituation.ThecashoutlaysdonebeforeDavid
andAnndecidedtorentouttheirhomewouldbeclassifiedassunkcosts.Anopportunity
costorcashflowisonethatcanberealizedfromanalternativeuseofanexistingasset.
Here,DavidandAnnhavedecidedtorentouttheirhome,andallthecostsassociatedwith
gettingthehomeinrentableconditionwouldberelevant.
b.
Sunkcosts(cashflows):
Replacewaterheater
Replacedishwasher
Miscellaneousrepairsandmaintenance
Opportunitycostscashflows:
Rentalincome
Advertising
Housepaintandpowerwash
P117. Bookvalue
LG3;Basic
Installed
Cost
Accumulated
Depreciation
Book
Value
$950,000
$674,500
$275,500
40,000
13,200
26,800
Asset
96,000
79,680
16,320
350,000
70,000
280,000
1,500,000
1,170,000
330,000
P118. Bookvalueandtaxesonsaleofassets
LG3,4;Intermediate
a.
Bookvalue$80,000(0.71$80,000)
$23,200
b.
SalePrice
Capital
Gain
Taxon
CapitalGain
Depreciation
Recovery
Taxon
Recovery
Total
Tax
$100,000
$20,000
$8,000
$56,800
$22,720
$30,720
56,000
32,800
13,120
13,120
23,200
15,000
(8,200)
(3,280)
(3,280)
P119. Taxcalculations
LG3,4;Intermediate
Currentbookvalue$200,000[(0.52($200,000)]$96,000
(a)
(b)
(c)
(d)
Capitalgain
$20,000
$0
$0
Recaptureddepreciation
104,000
54,000
8,000
41,600
21,600
(6,400)
$49,600
$21,600
$0
($6,400)
Taxoncapitalgain
$0
(16,000)
Taxondepreciation
Recovery
Totaltax
P1110. Changeinnetworkingcapitalcalculation
LG3;Basic
a.
CurrentAssets
Cash
CurrentLiabilities
$15,000
Accountspayable
$90,000
Accountsreceivable
150,000
Inventory
10,000
Netchange
$155,000
$130,000
Accruals
40,000
Networkingcapitalcurrentassetscurrentliabilities
NWC$155,000$130,000
NWC$25,000
b.
Analysisofthepurchaseofanewmachinerevealsanincreaseinnetworkingcapital.This
increaseshouldbetreatedasaninitialoutlayandisacostofacquiringthenewmachine.
c.
Yes,incomputingtheterminalcashflow,thenetworkingcapitalincreaseshouldbe
reversed.
P1111. Calculatinginitialinvestment
LG3,4;Intermediate
a.
Bookvalue$325,000(10.200.32)$325,0000.48$156,000
b.
Salespriceofoldequipment
$200,000
Bookvalueofoldequipment
156,000
Recaptureofdepreciation
$44,000
Taxesonrecaptureofdepreciation$44,0000.40$17,600
Aftertaxproceeds$200,000$17,600$182,400
c.
Costofnewmachine
Lesssalespriceofoldmachine
Plustaxonrecaptureofdepreciation
Initialinvestment
$500,000
(200,000)
17,600
$317,600
P1112.Initialinvestmentbasiccalculation
LG3,4;Intermediate
Installedcostofnewasset
Costofnewasset
$35,000
Installationcosts
5,000
Totalinstalledcost(depreciablevalue)
$40,000
Aftertaxproceedsfromsaleofoldasset
Proceedsfromsaleofoldasset
($25,000)
Taxonsaleofoldasset
7,680
Totalaftertaxproceedsoldasset
($17,320)
Initialinvestment
$22,680
Bookvalueofexistingmachine $20,000(1(0.200.320.19))$5,800
Recaptureddepreciation $20,000$5,800 $14,200
$25,000$20,000 $5,000
Capitalgain
Taxonrecaptureddepreciation $14,200(0.40) $5,680

Taxoncapitalgain
$5,000(0.40) 2,000
Totaltax
$7,680
P1113. Initialinvestmentatvarioussaleprices
LG3,4;Intermediate
(a)
(b)
(c)
(d)
$24,000
$24,000
$24,000
$24,000
Installationcost
2,000
2,000
2,000
2,000
Totalinstalledcost
26,000
26,000
26,000
26,000
(11,000)
(7,000)
(2,900)
(1,500)
3,240
1,640
(560)
(7,760)
(5,360)
(2,900)
(2,060)
$20,640
$23,100
Installedcostofnewasset:
Costofnewasset
Aftertaxproceedsfromsale
ofoldasset
Proceedsfromsale
ofoldasset
Taxonsaleofoldasset*
Totalaftertaxproceeds
Initialinvestment
$18,240
$23,940
Bookvalueofexistingmachine$10,000[1(0.200.320.19)]$2,900
*
TaxCalculations:
a.
b.
Recaptureddepreciation $10,000$2,900
$7,100
Capitalgain
$11,000$10,000 $1,000
Taxonordinarygain
$7,100(0.40)
$2,840
Taxoncapitalgain
$1,000(0.40)
Totaltax
$3,240
Recaptureddepreciation $7,000$2,900
Taxonordinarygain
400
$4,100(0.40)
c.
0taxliability
d.
Lossonsaleofexistingasset
$4,100
$1,640
$1,500$2,900
$1,400(0.40)
Taxbenefit
($1,400)
$560
P1114. Calculatinginitialinvestment
LG3,4;Challenge
a.
Bookvalue($60,0000.31)$18,600
b.
Salespriceofoldequipment
$35,000
Bookvalueofoldequipment
18,600
Recaptureofdepreciation
$16,400
Taxesonrecaptureofdepreciation$16,4000.40$6,560
Salepriceofoldroaster
$35,000
Taxonrecaptureofdepreciation
(6,560)
Aftertaxproceedsfromsaleofoldroaster $28,440
c.
Changesincurrentassetaccounts
Inventory
$50,000
Accountsreceivable
70,000
Netchange
$120,000
Changesincurrentliabilityaccounts
Accruals $(20,000)
Accountspayable 40,000
Notespayable 15,000
Netchange
$35,000
Changeinnetworkingcapital
d.
Costofnewroaster
Lessaftertaxproceedsfromsaleofoldroaster
Pluschangeinnetworkingcapital
Initialinvestment
$85,000
$130,000
28,440
85,000
$186,560
P1115. Depreciation
LG5;Basic
DepreciationSchedule
Year
DepreciationExpense
$68,000 0.20 $13,600
2
3
4
5
6
68,000
68,000
68,000
68,000
68,000
0.32 21,760
0.19 12,920
0.12 8,160
0.12 8,160
0.05 3,400
P1116. Incrementaloperatingcashinflows
LG5;Intermediate
a.
Incrementalprofitsbeforedepreciationandtax $1,200,000$480,000
$720,000eachyear
b.
Year
(1)
(2)
(3)
(4)
(5)
(6)
PBDT
$720,000
$720,000
$720,000
$720,000
$720,000
$720,000
Depr.
400,000
640,000
380,000
240,000
240,000
100,000
NPBT
320,000
80,000
340,000
480,000
480,000
620,000
Tax
128,000
32,000
136,000
192,000
192,000
248,000
NPAT
192,000
48,000
204,000
288,000
288,000
372,000
c.
Cash
flow
(1)
$592,000
(2)
$688,000
(3)
$584,000
(4)
$528,000
(5)
$528,000
(6)
$472,000
(NPATdepreciation)
PBDTProfitsbeforedepreciationandtaxes
NPBTNetprofitsbeforetaxes
NPATNetprofitsaftertaxes
P1117. Personalfinance:Incrementaloperatingcashinflows
LG5;Challenge
RichardandLindaThomson
IncrementalOperatingCashFlows
ReplacementofJohnDeereRidingMower
Year1 Year2 Year3 Year4 Year5
Savingsfromnewandimprovedmower
$500
$500
$500
$500
$500
Annualmaintenancecost
120
120
120
120
120
*
Depreciation
360
576
342
216
216
Savings(loss)beforetaxes
20
(196)
38
164
164
Taxes(40%)
8
(78)
15
66
66
Savings(loss)aftertaxes
12
(118)
23
98
98
Depreciation
360
576
342
216
216
Incrementaloperatingcashflow
$372
$458
$365
$314
$314
MACRSDepreciationSchedule
Year
Base
MACRS
*
Depreciation
Year6
0
90
(90)
(36)
(54)
90
$36
Year1
Year2
Year3
Year4
Year5
Year6
$1,800
1,800
1,800
1,800
1,800
1,800
20.0%
32.0%
19.0%
12.0%
12.0%
5.0%
$360
576
342
216
216
90
P1118. Incrementaloperatingcashinflowsexpensereduction
LG5;Intermediate
Year
(1)
Incremental
expensesavings
Incrementalprofits
beforedep.andtaxes*
Depreciation
Netprofits
beforetaxes
Taxes
Netprofits
aftertaxes
Operatingcash
inflows**
*
(2)
(3)
(4)
(5)
(6)
$16,000
$16,000
$16,000
$16,000
$16,000
$0
16,000
9,600
16,000
15,360
16,000
9,120
16,000
5,760
16,000
5,760
0
2,400
6,400
2,560
640
256
6,880
2,752
10,240
4,096
10,240
4,096
2,400
960
3,840
384
4,128
6,144
6,144
1,440
13,440
15,744
13,248
11,904
11,904
960
Incrementalprofitsbeforedepreciationandtaxeswillincreasethesameamountasthedecreaseinexpenses.
**
Netprofitsaftertaxesplusdepreciationexpense.
P1119. Incrementaloperatingcashinflows
LG5;Intermediate
a.
Expenses
(excluding Profitsbefore
depreciation Depreciation
Revenue andinterest)
andTaxes
Year
Depre
ciation
Net
Profits
before
Taxes
Taxes
Net
Operating
Profits
Cash
afterTax Inflows
NewLathe
1
$40,000
$30,000
$10,000
$2,000
$8,000 $3,200
$4,800
$6,800
41,000
30,000
11,000
3,200
7,800
3,120
4,680
7,880
42,000
30,000
12,000
1,900
10,100
4,040
6,060
7,960
43,000
30,000
13,000
1,200
11,800
4,720
7,080
8,280
44,000
30,000
14,000
1,200
12,800
5,120
7,680
8,880
500
$35,000
$25,000
$10,000
(500)
(200)
(300)
200
OldLathe
15
b.
$10,000
$4,000
Calculationofincrementalcashinflows
$6,000
$6,000
Year
NewLathe
OldLathe
IncrementalCashFlows
$6,800
$6,000
$800
7,880
6,000
1,880
7,960
6,000
1,960
8,280
6,000
2,280
8,880
6,000
2,880
200
200
c.
P1120. Determiningincrementaloperatingcashflows
LG5;Intermediate
Year
1
$1,850
1,800
$50
$1,830
1,790
$40
$1,825
1,785
$40
$1,815
1,775
$40
$1,800
1,750
$50
$460
510
$(50)
$468
520
$(52)
$472
520
$(48)
$485
530
$(45)
$500
535
$(35)
$960
135
$825
$570
0
$570
$360
0
$360
$360
0
$360
$150
0
$150
330
228
144
144
60
$50
40
(36)
110
$50
50
(40)
330
$40
52
(37)
228
$40
48
(35)
144
$40
45
(34)
144
$50
35
(34)
60
$164
$390
$283
$197
$195
Revenues:(000)
Newbuses
$1,850
Oldbuses
1,800
Incrementalrevenue
$50
Expenses:(000)
Newbuses
$460
Oldbuses
500
Incrementalexpense $(40)
Depreciation:(000)
Newbuses
$600
Oldbuses
324
Incrementaldepr.
$276
Incrementaldepr.tax
savings@40%
110
NetIncrementalCashFlows
Cashflows:(000)
Revenues
Expenses
Lesstaxes@40%
Depr.taxsavings
Netoperatingcash
inflows
$111
P1121. Terminalcashflowsvariouslivesandsaleprices
LG6;Challenge
a.
Aftertaxproceedsfromsaleofnewasset 3Year*
Proceedsfromsaleofproposedasset
Taxonsaleofproposedasset*
Totalaftertaxproceedsnew
5Year*
7Year*
$10,000
$10,000
$10,000
16,880
400
4,000
$26,880
$9,600
$6,000
30,000
30,000
30,000
Terminalcashflow
$56,880
$39,600
$36,000
*
1.
Bookvalueofasset [1(0.200.320.19)]$180,000$52,200
Proceedsfromsale $10,000
$10,000$52,200 ($42,200)loss
$42,200(0.40)
2.
3.
$16,880taxbenefit
Bookvalueofasset [1(0.200.320.190.120.12)]$180,000$9,000
$10,000$9,000
$1,000recaptureddepreciation
$1,000(0.40)
$400taxliability
Bookvalueofasset $0
$10,000$0
$10,000(0.40)
$4,000taxliability
b. Iftheusablelifeislessthanthenormalrecoveryperiod,theassethasnotbeendepreciated
fullyandataxbenefitmaybetakenontheloss;therefore,theterminalcashflowishigher.
c.
(1)
(2)
$9,000
$170,000
Aftertaxproceedsfromsaleofnewasset
Proceedsfromsaleofnewasset
Taxonsaleofproposedasset
30,000
30,000
$39,000
$135,600
Terminalcashflow
(64,400)
1.
Bookvalueoftheasset$180,0000.05$9,000;notaxesaredue
2.
Tax($170,000$9,000)0.4$64,400.
d. Thehigherthesaleprice,thehighertheterminalcashflow.
P1122. Terminalcashflowreplacementdecision
LG6;Challenge
Proceedsfromsaleofnewmachine
$75,000
Taxonsaleofnewmachinel
(14,360)
Totalaftertaxproceedsnewasset
$60,640
Proceedsfromsaleofoldmachine
Taxonsaleofoldmachine
(15,000)
6,000
Totalaftertaxproceedsoldasset
25,000
Terminalcashflow
1
(9,000)
$76,640
Bookvalueofnewmachineatendofyear4:
[1(0.200.320.190.12)($230,000)] $39,100
$75,000$39,100
$14,360taxliability
$35,900(0.40)
2
Bookvalueofoldmachineatendofyear4:
$0
$15,000$0
$15,000(0.40)
$6,000taxbenefit
P1123. Relevantcashflowsforamarketingcampaign
LG3,4,5,6;Challenge
MarcusTube
CalculationofRelevantCashFlow
($000)
CalculationofNetProfitsafterTaxesandOperatingCashFlow:
withMarketingCampaign
2013
2014
2015
2016
2017
Sales
$20,500
$21,000
$21,500
$22,500
$23,500
CGS(@80%)
16,400
16,800
17,200
18,000
18,800
Grossprofit
$4,100
$4,200
$4,300
$4,500
$4,700
$2,050
$2,100
$2,150
$2,250
$2,350
Marketingcampaign
150
150
150
150
150
Depreciation
500
500
500
500
500
2,700
2,750
2,800
2,900
3,000
$1,400
$1,450
$1,500
$1,600
$1,700
560
580
600
640
680
$840
$870
$900
$960
$1,020
500
500
500
500
500
$1,340
$1,370
$1,400
$1,460
$1,520
Less:Less:Operatingexpenses
Generaland
administrative
(10%ofsales)
Totaloperating
expenses
Netprofit
beforetaxes
Less:Taxes40%
Netprofit
aftertaxes
Depreciation
OperatingCF
WithoutMarketingCampaign
Years20132017
Netprofitaftertaxes
Depreciation
$900
500
Operatingcashflow
$1,400
RelevantCashFlow
($000)
Year
WithMarketing
Campaign
WithoutMarketing Incremental
Campaign
CashFlow
2013
$1,340
$1,400
$(60)
2014
1,370
1,400
(30)
2015
1,400
1,400
2016
1,460
1,400
60
2017
1,520
1,400
120
P1124. Relevantcashflowsnoterminalvalue
LG3,4,5;Challenge
a.
Costofnewasset
$76,000
Installationcosts
4,000
Totalcostofnewasset
$80,000
(55,000)
16,200
Totalproceeds,saleofoldasset
(38,800)
Initialinvestment
*
$41,200
Bookvalueofoldmachine:
[1(0.200.320.19)]$50,000
$14,500
$55,000$14,500
$40,500 gainonasset
$35,500recaptureddepreciation0.40
$14,200
$5,000capitalgain0.40
Totaltaxonsaleofasset
$16,200
2,000
b.
CalculationofOperatingCashFlow
Year
(1)
(2)
(3)
(4)
(5)
(6)
$14,000
$16,000
$20,000
$18,000
$14,000
$0
6,000
6,000
2,500
NPBT
$8,000
$10,000
$17,500
$18,000
$14,000
Taxes
3,200
4,000
7,000
7,200
5,600
NPAT
$4,800
$6,000
$10,500
$10,800
$8,400
$0
6,000
6,000
2,500
$10,800
$12,000
$13,000
$10,800
$8,400
$0
PBDT
$30,000
$30,000
$30,000
$30,000
$30,000
$0
Depreciation
16,000
25,600
15,200
9,600
9,600
4,000
NPBT
$14,000
$4,400
$14,800
$20,400
$20,400
$4,000
OldMachine
PBDT
Depreciation
Depreciation
Cashflow
NewMachine
Taxes
5,600
1,760
5,920
8,160
8,160
1,600
NPAT
$8,400
$2,640
$8,880
$12,240
$12,240
$2,400
Depreciation
16,000
25,600
15,200
9,600
9,600
4,000
Cashflow
$24,400
$28,240
$24,080
$21,840
$21,840
$1,600
$13,600
$16,240
$11,080
$11,040
$13,440
$1,600
Incremental
Aftertax
cashflows
c.
P1125. Integrativedeterminingrelevantcashflows
LG3,4,5,6;Challenge
a.
Initialinvestment:
Costofnewasset
$105,000
Installationcosts
5,000
Totalcostofnewasset
$110,000
(70,000)
Taxonsaleofoldasset
16,480
Totalproceedsfromsaleofoldasset
(53,520)
Changeinworkingcapital
12,000
Initialinvestment
*
$68,480
Bookvalueofoldasset:
[1(0.200.32)]$60,000
$28,800
$70,000$28,800$41,200gainonsaleofasset
$31,200recaptureddepreciation0.40 $12,480
$10,000capitalgain0.40
Totaltaxofsaleofasset
$16,480
4,000
b.
Year
CalculationofOperatingCashInflows
Profitsbefore
Depreciation
NetProfits
NetProfits
andTaxes Depreciation beforeTaxes Taxes afterTaxes
Operating
Cash
Inflows
NewGrinder
1
$43,000
2
43,000
3
43,000
4
43,000
5
43,000
6
0
ExistingGrinder
1
$26,000
2
24,000
3
22,000
$22,000
35,200
20,900
13,200
13,200
5,500
$21,000
7,800
22,100
29,800
29,800
5,500
$8,400
3,120
8,840
11,920
11,920
2,200
$12,600
4,680
13,260
17,880
17,880
3,300
$34,600
39,880
34,160
31,080
31,080
2,200
$11,400
7,200
7,200
$14,600
16,800
14,800
$5,840
6,720
5,920
$8,760
10,080
8,880
$20,160
17,280
16,080
4
5
6
20,000
18,000
0
3,000
0
0
17,000
18,000
0
6,800
7,200
0
10,200
10,800
0
CalculationofIncrementalCashInflows
Year
c.
IncrementalOperating
NewGrinder ExistingGrinder
CashFlow
$34,600
$20,160
$14,440
39,880
17,280
22,600
34,160
16,080
18,080
31,080
13,200
17,880
31,080
10,800
20,280
2,200
2,200
Terminalcashflow:
Taxonsaleofnewasset
$29,000
(9,400)
Totalproceedsfromsaleofnewasset
19,600
Taxonsaleofoldasset
Totalproceedsfromsaleofoldasset
12,000
Terminalcashflow
*
d.
0
$31,600
Bookvalueofassetatendofyear5 $5,500
$29,000$5,500
$23,500 recaptureddepreciation
$23,5000.40
$9,400
Year5relevantcashflow:
Operatingcashflow
$20,280
Terminalcashflow
31,600
Totalinflow
$51,880
13,200
10,800
0
P1126. Personalfinance:Determiningrelevantcashflowsforacashbudget
LG3,4,5,6;Challenge
JanandDeana
CashFlowBudget
PurchaseofBoat
a. Initialinvestment
Totalcostofnewboat
Add:Taxes(6.5%)
Initialinvestment
$(70,000)
(4,550)
$(74,550)
b. Operatingcashflows
Maint.&repair
12monthsat$800
Dockingfees
12monthsat$500
Operatingcashflows
Year1
$(9,600)
$(6,000)
$(15,600)
Year2
$(9,600)
$(6,000)
$(15,600)
Year3
$(9,600)
$(6,000)
$(15,600)
c. Terminalcashflowendofyear4
Proceedsfromthesaleofboat
d. Summaryofcashflows
Yearzero
Endofyear1
Endofyear2
Endofyear3
Endofyear4
Year4
$(9,600)
$(6,000)
$(15,600)
$40,000
CashFlow
$(74,550)
$(15,600)
$(15,600)
$(15,600)
$24,400
e. Theownershipoftheboatisvirtuallyjustanannualoutflowofmoney.Acrossthefouryears,
$96,950willbespentinexcessoftheanticipatedsalespriceinyear4.Overthesametime
period,thedisposableincomeisonly$96,000.Consequently,ifthecostsexceedtheexpected
disposableincome.Ifcashflowswereadjustedfortheirtiming,andnotingthattheproceeds
fromthesaleofthenewboatcomesinfirstattheendofyear4,JanandDeanaareina
positionwheretheywillhavetoincreasetheirdisposableincomeinordertoaccommodate
boatownership.Ifaloanisneeded,themonthlyinterestpaymentwouldbeanotherburden.
However,thereisnoattemptheretomeasuresatisfactionofownership.
P1127. Integrativedeterminingrelevantcashflows
LG3,4,5,6;Challenge
a.
InitialInvestment
Costofnewasset
$40,000
$54,000
Installationcosts
8,000
6,000
Totalproceeds,saleofnewasset
48,000
60,000
Initialinvestment
*
Bookvalueofoldasset:
(18,000)
(18,000)
3,488
3,488
(14,512)
(14,512)
4,000
6,000
$37,488
$51,48
8
[1(0.200.320.19)]($32,000)$9,280
b.
Profits
before
Depreciation
andTaxes
Depre
ciation
NetProfits
before
Taxes
Taxes
$21,000
$9,600
$11,400
$4,560
$6,840
$16,440
21,000
15,360
5,640
2,256
3,384
18,744
21,000
9,120
11,880
4,752
7,128
16,248
21,000
5,760
15,240
6,096
9,144
14,904
21,000
5,760
15,240
6,096
9,144
14,904
2,400
2,400
960
1,440
960
$22,000
$12,000
$10,000
$4,000
$6,000
18,000
24,000
19,200
4,800
1,920
2,880
22,080
26,000
11,400
14,600
5,840
8,760
20,160
26,000
7,200
18,800
7,520
11,280
18,480
26,000
7,200
18,800
7,520
11,280
18,480
3,000
3,000
1,200
1,800
1,200
$14,000
$3,840
$10,160
$4,064
$6,096
$9,936
14,000
3,840
10,160
4,064
6,096
9,936
14,000
1,600
12,400
4,960
7,440
9,040
14,000
14,000
5,600
8,400
8,400
14,000
14,000
5,600
8,400
8,400
Year
NetProfits Operating
after
Cash
Taxes
Inflows
HoistA
HoistB
ExistingHoist
Incremental
CashFlow
Year
HoistA
HoistB
ExistingHoist
HoistA
HoistB
$16,440
$18,000
$9,936
$6,504
$8,064
18,744
22,080
9,936
8,808
12,144
16,248
20,160
9,040
7,208
11,120
14,904
18,480
8,400
6,504
10,080
14,904
18,480
8,400
6,504
10,080
960
1,200
960
1,200
c.
Terminalcashflow:
(A)
(B)
$12,000
$20,000
Aftertaxproceedsformsaleofnewasset
Taxonsaleofnewassetl
Totalproceedsnewasset
(3,840)
(6,800)
8,160
13,200
(1,000)
(1,000)
400
400
(600)
(600)
Taxonsaleofoldasset2
Totalproceedsoldasset
Terminalcashflow
1
4,000
6,000
$11,560
$18,600
BookvalueofHoistAatendofyear5$2,400
$12,000$2,400 $9,600recaptureddepreciation
$9,6000.40
$3,840tax
BookvalueofHoistBatendofyear5$3,000
$17,0000.40
2
$6,800tax
Bookvalueofexistinghoistatendofyear5$0
$1,000$0
$1,0000.40
$400tax
Year5relevantcashflowHoistA:
Operatingcashflow
$6,504
Terminalcashflow
11,560
Totalinflow
$18,064
Year5relevantcashflowHoistB:
Operatingcashflow
$10,080
Terminalcashflow
18,600
Totalinflow
$28,680
d.
P1128. Integrativecompleteinvestmentdecision
LG1,2,3,4,5,6;Challenge
a.
Initialinvestment:
Installedcostofnewpress
Costofnewpress
$2,200,000
Proceedsfromsaleofexistingpress
(1,200,000)
Taxesonsaleofexistingpress*
480,000
Totalaftertaxproceedsfromsale
(720,000)
Initialinvestment
$1,480,000
*
Bookvalue$0
$1,200,000$0$1,200,000incomefromsaleofexistingpress
$1,200,000incomefromsale(0.40)$480,000
b.
Year Revenues
CalculationofOperatingCashFlows
NetProfits
Expenses Depreciation beforeTaxes
Taxes
NetProfits
afterTaxes
1
2
3
4
5
6
$800,000
800,000
800,000
800,000
800,000
0
$216,000
57,600
229,200
321,600
321,600
66,000
$1,600,000
1,600,000
1,600,000
1,600,000
1,600,000
0
c.
$440,000
704,000
418,000
264,000
264,000
110,000
$360,000
96,000
382,000
536,000
536,000
110,000
$144,000
38,400
152,800
214,400
214,400
44,000
Paybackperiod2years($62,400$647,200)2.1years
d. PVofcashinflows:
CF0$1,480,000,CF1$656,000,CF2$761,600,CF3$647,200,
CF4$585,600,CF5585,600,CF6$44,000
SetI11
SolveforNPV$959,152
Year
1
2
3
4
5
6
CF
PVIF11%,n
$656,000
761,600
647,200
585,600
585,600
44,000
0.901
0.812
0.731
0.659
0.593
0.535
PV
$591,056
618,419
473,103
385,910
347,261
23,540
Cash
Flow
$656,000
761,600
647,200
585,600
585,600
44,000
$2,439,289
$0
$656,000 $761,600 $647,200 $585,600 $585,600

$44,000
$1,480,000
1
2
3
4
5
(1 IRR) (1 IRR) (1 IRR) (1 IRR) (1 IRR) (1 IRR)6
IRR35%
Calculatorsolution:35.04%
e.
TheNPVisapositive$959,289andtheIRRof35%iswellabovethecostofcapitalof11%.
Basedonbothdecisioncriteria,theprojectshouldbeaccepted.
P1129. Integrativeinvestmentdecision
LG1,2,3,4,5,6;Challenge
a.
Initialinvestment:
Costofthenewmachine
$1,200,000
Installationcosts
150,000
Totalcostofnewmachine
$1,350,000
Proceedsfromsaleofexistingmachine
Taxonsaleofexistingmachine
(185,000)
(79,600)
Totalaftertaxproceedsfromsale
(264,600)
Increaseinnetworkingcapital
25,000
Initialinvestment
$1,110,400
Bookvalue$384,000
$185,000$384,000$199,000lossfromsaleofexistingpress
$199,000lossfromsale(0.40)$79,600
CalculationofOperatingCashFlows
NewMachine
Reductionin
NetProfits
Year OperatingCosts Depreciation beforeTaxes Taxes
1
2
3
4
5
6
$350,000
350,000
350,000
350,000
350,000
0
$270,000
432,000
256,500
162,000
162,000
67,500
$80,000
82,000
93,500
188,000
188,000
67,500
$32,000
32,800
37,400
75,200
75,200
27,000
NetProfits
afterTaxes
$48,000
49,200
56,100
112,800
112,800
40,500
Cash
Flow
$318,000
382,800
312,600
274,800
274,800
27,000
Year
1
2
3
4
5
6
ExistingMachine
NetProfits
beforeTaxes
Taxes
Depreciation
$152,000
96,000
96,000
40,000
0
0
$152,000
96,000
96,000
40,000
0
0
Year
NetProfits
afterTaxes
$60,800
38,400
38,400
16,000
0
0
$91,200
57,600
57,600
24,000
0
0
IncrementalOperatingCashFlows
NewMachine
ExistingMachine IncrementalCashFlow
$318,000
$60,800
$257,200
382,800
38,400
344,400
312,600
38,400
274,200
274,800
16,000
258,800
274,800
274,800
27,000
27,000
Terminalcashflow:
Taxonsaleofnewasset
$200,000
(53,000)
Totalproceedssaleofnewasset
$147,000
Terminalcashflow
25,000
$172,000
Bookvalueofnewmachineattheendofyear5is$67,500
200,000$67,500$132,500incomefromsaleofoldmachine
132,5000.40$53,000taxliability
b. CF0$1,110,400,CF1257,200,CF2$344,400,CF3$274,200,
CF4$258,800,CF5$274,800172,000$446,800
SetI9%
SolveforNPV=$100,900.39
Cash
Flow
$60,800
38,400
38,400
16,000
0
0
$0
$257,200 $344,400 $274,200 $258,800 $446,800
$1,110,400
(1 IRR)1 (1 IRR) 2 (1 IRR)3 (1 IRR) 4 (1 IRR)5
c.
IRR12.2%
Calculatorsolution:12.24%
d. SincetheNPV0andtheIRRcostofcapital,thenewmachineshouldbepurchased.
e.
12.24%.ThecriterionisthattheIRRmustequalorexceedthecostofcapital;therefore,
12.24%isthelowestacceptableIRR.
P1130. Ethicsproblem
LG2;Intermediate
Thepersonwhocameupwiththeideaforanewinvestmentmayhaveanselfishinterestinseeing
theprojectapproved,ormaysimplybeemotionallyvestedintheproject.Ineithercase,thisindividual
mayhaveanincentivetomakeoverlyoptimisticcashflowprojections.Itisbesttohaveanobjective
thirdpartyberesponsibleforcashflowprojections.
Case
Casestudiesareavailableonwww.myfinancelab.com.
Developing Relevant Cash Flows for Clark Upholstery Companys Machine

Renewal or Replacement Decision
ClarkUpholsteryisfacedwithadecisiontoeitherrenewitsmajorpieceofmachineryortoreplacethe
machine.Thecaseteststhestudentsunderstandingoftheconceptsofinitialinvestmentandrelevantcash
flows.
a.
InitialInvestment:
Alternative1
Alternative2
$90,000
$100,000
10,000
90,000
110,000
Costofasset
Installationcosts
(20,000)
8,000
(12,000)
Initialinvestment
*
15,000
22,000
$105,000
$120,000
Bookvalueofoldasset 0
$20,000$0
$20,000(0.40)
$8,000tax
b.
Profitsbefore
Depreciation
andTaxes
Year
Depre
ciation
NetProfits
beforeTaxes Taxes
Operating
NetProfits
Cash
afterTaxes Inflows
Alternative1
1
$198,500
$18,000
$180,500
$72,200 $108,300
$126,300
290,800
28,800
262,000
104,800
157,200
186,000
381,900
17,100
364,800
145,920
218,880
235,980
481,900
10,800
471,100
188,440
282,660
293,460
581,900
10,800
571,100
228,440
342,660
353,460
4,500
4,500
1,800
2,700
1,800
$235,500
$22,000
$213,500
$85,400 $128,100
$150,100
335,200
35,200
300,000
120,000
180,000
215,200
385,100
20,900
364,200
145,680
218,520
239,420
435,100
13,200
421,900
168,760
253,140
266,340
551,100
13,200
537,900
215,160
322,740
335,940
5,500
5,500
2,200
3,300
2,200
Alternative2
IncrementalCashFlow
Year
Alternative1
Alternative2
Existing
Alt.1
Alt.2
$126,300
$150,100
$100,000
$26,300
$50,100
186,000
215,200
150,000
36,000
65,200
235,980
239,420
200,000
35,980
39,420
293,460
266,340
250,000
43,460
16,340
353,460
335,940
320,000
33,460
15,940
1,800
2,200
1,800
2,200
c.
TerminalCashFlow:
Alternative1
Alternative2
Aftertaxproceedsfrom
saleofnewasset
$8,000
Taxonsaleofnewasset*
$25,000
(1,400)
(7,800)
6,600
17,200
(2,000)
(2,000)
800
800
(1,200)
(1,200)
Taxonsaleofoldasset**
15,000
22,000
Terminalcashflow
$20,400
$38,000
BookvalueofAlternative1atendofyear5: $4,500
$3,500(0.40)
$1,400tax
BookvalueofAlternative2atendofyear5: $5,500
$19,500(0.40) $7,800tax
**
Bookvalueofoldassetatendofyear5:$0
$2,000$0
$2,000(0.40)
$800tax
Alternative1
Operatingcashflow:
$33,460
Terminalcashflow
20,400
Totalcashinflow
$53,860
Operatingcashflow:
$15,940
Terminalcashflow
38,000
Totalcashinflow
$53,940
Alternative2
d.
Alternative1
e.
Alternative2appearstobeslightlybetterbecauseithasthelargerincrementalcashflowamounts
intheearlyyears.Assuminga9%discountrate,theNPVofAlternative1is$43,005.50,whilethe
NPVofAlternative2is$57,913.27.TheIRRofAlternative2,27.77%,isalsohigherthantheIRR
ofAlternative1,whichis22.04%.
Spreadsheet Exercise
TheanswertoChapter11sDamonCorporationspreadsheetproblemislocatedontheInstructors
ResourceCenteratwww.pearsonhighered.com/ircundertheInstructorsManual.
Group Exercise
Groupexercisesareavailableonwww.myfinancelab.com.
Capitalinvestmentisrevisitedinthischapter.Alongterminvestmentprojectwillbedetailedacrossthis
andthefollowingtwochapters.Studentsarewarnedthatwhilethischaptersexerciseisapparentlybrief,
theworkisvitaltotheworkinthefollowingchapters.
Thefirsttaskistodesigntwomutuallyexclusiveinvestmentprojects.Thedesignshouldfocusonwhy
theseinvestmentsshouldeachbeundertaken.Afterestablishingthewhyforeachproject,theprocess
ofrigorousnumericalanalysisisbegun.Cashflowsaretobeestimatedandstudentsshouldbeencouraged
tousesimpleroundnumberswhenestimatingtheinitialinvestmentandoperating/terminalcashflows.All
numbersshouldbeorganizedonanannualbasis.Eachgroupisaskedtodesignatimelinewithaminimum
of5yearsforeachprojectsnumbers.Themostfeasibleestimateswillrunfrom510years.
Apaybackperiod,netpresentvalue,andinternalrateofreturnareestimatedforbothprojects.Ifthe
projectshavedifferentsizes,itmaybepossibleforthesmallerprojecttohaveahigherinternalrateof
returnbutalowernetpresentvalue.Givinggroupsavarietyofdiscountratestouseintheanalysisalso
addstotherichnessoftheproject.

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Chapter 11

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Chapter11

Suggested Answer to Opener in Review Question

Answers to Review Questions

Suggested Answer to Global Focus Box:

Suggested Answer to Focus on Ethics Box:

Answers to Warm-Up Exercises

Taxonrecaptureddepreciation $14,200(0.40) $5,680

$68,000 0.20 $13,600

$656,000 $761,600 $647,200 $585,600 $585,600

$257,200 $344,400 $274,200 $258,800 $446,800

Developing Relevant Cash Flows for Clark Upholstery Companys Machine

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