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XYZ Company, a'for-profit' business, had revenues of $15 million in 2018.Expenses other than depreciation totaled 75 percent of revenues.XYZ Company, must pay taxes at a rate of 40 percent of pretax(operating) income. All revenues were collected in cash during theyear, and all expenses other than depreciation were paid incash.

Depreciationoriginally was $1.5 million; however, now the company has decidedto be more conservative in its depreciation of its capital assets.XYZ now has $750,000 in depreciation expense instead of $1.5million.

Based on this changein depreciation expense, what would XYZ's cash flow be?

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Bunny Greenfelder
Bunny GreenfelderLv2
28 Sep 2019

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XYZ Company, a'for-profit' business, had revenues of $15 million in 2018.Expenses other than depreciation totaled 75 percent of revenues.XYZ Company, must pay taxes at a rate of 40 percent of pretax(operating) income. All revenues were collected in cash during theyear, and all expenses other than depreciation were paid incash.

Depreciationoriginally was $1.3 million; however, a change in the depreciationschedule (still within GAAP) has now made the depreciation expenseDOUBLE.

Based on this changein depreciation expense, what would XYZ's net income now be?

Select one or more:

a. $1,000,000

b. $500,000

c. $690,000

d. $1,350,000

Cleaner Than Dirt manufactures a variety of household products. The company is considering
introducing a new household cleaning product. The company’s CFO has collected the following
information about the proposed product. (Note: You may or may not need to use all of this information,
use only the information that is relevant.)
• The project has an anticipated economic life of 4 years.
• The company will have to purchase a new machine to produce the product. The machine has an upfront
cost (t = 0) of $2 million. The machine will be depreciated on a straight-line basis over 4 years
(that is, the company’s depreciation expense will be $500,000 in each of the first four years (t = 1, 2,
3, and 4). The company anticipates that the machine will last for four years, and that after four
years, its salvage value will equal zero.
• If the company goes ahead with the proposed product, it will have an effect on the company’s net
operating working capital. At the outset, t = 0, inventory will increase by $140,000 and accounts
payable will increase by $40,000. At t = 4, the net operating working capital will be recovered after
the project is completed.
• The new product is expected to generate sales revenue of $1 million the first year (t = 1), $2 million
the second year (t = 2), $2 million the third year (t = 3), and $1 million the final year (t = 4). Each
year the operating costs (not including depreciation) are expected to equal 50 percent of sales
revenue.
• The company’s interest expense each year will be $100,000.
• The new product is expected to reduce the after-tax cash flows of the company’s existing products
by $250,000 a year (t = 1, 2 , 3, and 4).
• The company’s overall WACC is 10 percent. However, the proposed project is riskier than the
average project for Cleaner Than Dirt; the project’s WACC is estimated to be 12 percent.
• The company’s tax rate is 40 percent.
What is the net present value of the proposed project?

  • Braves Bus Tours wants to provide excursions to several national and international sports events that will be taking place throughout the country during the next few years. To make the buses more comfortable and the trips more popular, each of eight new buses will be equipped with a kitchen and a large video screen for movies and sports telecasts.

    Each bus costs $200,000 and requires customized equipment that costs an additional $100,000 per bus. All the buses and the equipment have a recovery period (MACRS life) of 5 years. An advertising campaign, which will start immediately, costs $750,000 and will be paid for immediately. Other start-up costs total $30,000.

    The sports trips are scheduled for 3-10 days and will generate revenues of $100 per day per seat. For the eight video buses, total revenues are expected to be $3,168,000 for the first year and $3,484800 for the second year (a 10% increase). Operating costs are 30% of total revenues. Personnel expenses, including driver salaries, are $650,000 in year 1 and will increase by 5% in year 2.

    The company expects to discontinue operation of its video bus tours after the second year. Each bus will be sold to a university for $35,000 ($30,000 for the bus itself and $5,000 for the equipment). The finance department has determined that the beta of this project is 1.5, while the market return is expected to be 14%. Treasury bills pay a nice safe 4 percent.

    Should the company proceed with this project? Demonstrate your decision by answering the following questions:

    • What are the cash flows for the initial investment period (CF0)?
    • What is the MACRS depreciation schedule for the first two years for all of the buses and the equipment? The fall into the MACRS 5 year class. See page 285 of the text.
    • What are the after-tax cash flows for the 2 years that the bus tours will be in operation if their tax rate is 34%?
    • What are the termination cash flows in year 2?
    • If NPV analysis is used, should the buses be purchased?

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