AFM102 Lecture Notes - Lecture 20: Working Capital, Cash Flow, Big Business

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apricottoad869

15 Oct 2015

School

University of Waterloo

Department

Accounting & Financial Management

Course

AFM102

Professor

Peter Blake

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Document Summary

Time value of money means must analyse based on pv (present value) of cash flows: use tables to get factors to arrive at pv (cash flow x factor = pv) Re-states all cash flows to today (pv) Business deciding whether or not to buy an additional stamping machine. Machine will generate additional margins (sales - variable costs) of ,000 per year for the next 8 years. Machine will last 8 years but will need a major overhaul after 5 years. Cost of the overhaul is ,000 and after 8 years, the machine as scarp value of ,000. Should the company buy the machine if the cost of capital is: 12, 5% A 55 year old woman deciding whether or not to open a small business. She wants to earn 12% on any investment. The business is a sell a product and sell a service. Equipment cost ,000 required immediately and sold in 10 years for 5% cost.

Related Questions

Assume you are the owner and operator of a textile manufacturer. You must evaluate the proposal of buying a new machine for your factory. The company has already spent $5,000 investigating the feasibility of using the machine. The price of the equipment is $120,000. Shipping and installation will cost an additional $10,000. The machine falls under the MACRS 3-year class; the applicable depreciation rates are 33%, 45%, 15%, and 7%. After using the machine for three years it would be sold for $71,500. The machine would require an increase in net operating working capital of $6,000. The machine would not impact revenues, but it would cause pre-tax labor costs to decline by $42,500 per year. The marginal tax rate is 35% and the cost of capital is 11%.

a. How should the $5,000 spent on a feasibility analysis be handled?

b. What is the initial investment cost for the machine (Year 0 cash flow)?

c. What are the annual cash flows for years 1, 2 and 3?

d. Find the projectâs NPV, IRR and MIRR.

e. Should you buy the machine? Explain your answer.

emeraldrat210

Capital Budgeting Problem

WRL Company operates a snack food center at the Hartsfield Airport.On January 1, 2003, WRL purchased a special cookie-cutting machine,which has been used for three years. It is January 1, 2006, and WRLis considering whether it should purchase a new, more-efficientcookie-cutting machine. WRL has two options:

(1) continue using the old machine or

(2) sell the old machine and purchase a new machine.

The seller of the new machine is not offering a trade-in. Thefollowing information has been obtained:

Item Old Machine New Machine
Initial purchase cost of machines $ 80,000 $ 120,000
Useful life from acquisition date ( years) 7 4
Terminal disposal value at the end of useful life on
Dec. 31, 2009, assumed for depreciation purposes $ 10,000 $20,000
Expected annual cash operating costs:
Variable cost per cookie $ 0.20 $ 0.14
Total fixed costs $ 15,000 $ 14,000
Estimated disposal value of machines:
January 1, 2006 $ 40,000 $120,000
December 31, 2009 $ 7,000 $ 20,000
Expected number of cookies made and sold each year 300,000300,000

WRL is subject to a 40% income tax rate. The straight-linedepreciation method is used for tax purposes. Assume that any gainor loss on the sale of machines is treated as an ordinary tax itemand will affect the taxes paid by WRL in the year in which itoccurs. WRLâs after- tax required rate of return is 16%. Assume allcash flows occur at year-end except for initial investmentamounts.

Required:

1. You have been asked whether WRL should buy the new machine. Tohelp in your analysis, calculate the following:

a. One- time after- tax cash effect of disposing of the oldmachine.

b. Annual recurring after- tax cash operating savings from usingthe new machine (variable and fixed).

c. Cash tax savings due to differences in annual depreciation ofthe old machine and the new machine.

d. Difference in after- tax cash flow from terminal disposal of newmachine and old machine.

2. Use your calculations in requirement 1 and the net present valuemethod to determine whether WRL should use the old machine oracquire the new machine.

3. How much more or less would the recurring after- tax cashoperating savings of the new machine need to be for WRL to earnexactly the 16% after- tax required rate of return? Assume that allother data about the investment do not change.

Comment

graylion535

Rockyford Company must replace some machinery that has zero book value and a current market value of $1,600. One possibility is to invest in new machinery costing $41,000. This new machinery would produce estimated annual pretax cash operating savings of $16,400. Assume the new machine will have a useful life of four years and depreciation of $10,250 each year for book and tax purposes. It will have no salvage value at the end of four years. The investment in this new machinery would require an additional $2,300 investment of net working capital. (Assume that when the old machine was purchased the incremental net working capital required at the time was $0.)

If Rockyford accepts this investment proposal, the disposal of the old machinery and the investment in the new one will occur on December 31 of this year. The cash flows from the investment will occur during the next four calendar years.

Rockyford is subject to a 40% income-tax rate for all ordinary income and capital gains and has a 11% weighted-average after-tax cost of capital. All operating and tax cash flows are assumed to occur at year-end. (For Parts 2 and 3, use the relevant table from Appendix CâTable 1 or Table 2.)

Required:

1.	Determine the after-tax cash flow arising from disposing of the old machinery.

2.	Determine the present value of the after-tax cash flows for the next four years attributable to the cash operating savings. (Round your answer to the nearest whole dollar amount.)

3.	Determine the present value of the tax shield effect of depreciation for year 1. (Round your answer to the nearest whole dollar amount.)

Which one of the following is the proper treatment for the additional $2,300 of net working capital required in the current year?

	It should be ignored in capital budgeting because it is not a capital investment.
	It is a sunk cost that needs no consideration in capital budgeting.
	It should be treated as part of the initial investment when determining the net present value.
	It should be spread over the machineryâs four-year life as a cash outflow in each of the years.
	It should be included as part of the cost of the new machine and depreciated. May I please receive a step-by-step walkthough for each problem.

ceruleancamel846

AFM102 Lecture Notes - Lecture 20: Working Capital, Cash Flow, Big Business

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