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Financial Management Assignment Notes

The document contains sample problems and solutions for a financial management assignment. Problem 1 involves calculating project cash flows, accounting for cannibalization of existing sales. Problem 2 deals with calculating the after-tax salvage value of equipment. Problem 3 provides details of a project's initial investment, annual cash flows, and terminal value, and calculates NPV, IRR, MIRR and payback period. Examples are also given of applying these concepts to sample numerical problems.

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83 views

Financial Management Assignment Notes

The document contains sample problems and solutions for a financial management assignment. Problem 1 involves calculating project cash flows, accounting for cannibalization of existing sales. Problem 2 deals with calculating the after-tax salvage value of equipment. Problem 3 provides details of a project's initial investment, annual cash flows, and terminal value, and calculates NPV, IRR, MIRR and payback period. Examples are also given of applying these concepts to sample numerical problems.

Uploaded by

Daniyal Ali
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Lahore School of Economics

Financial Management II
Cash Flow Estimation and Risk Analysis – 1
Assignment 8

Problems for Assignment


Q1) a. Project cash flows: t = 1
Sales revenues $10,000,000
Operating costs 7,000,000
Depreciation 2,000,000
EBIT $ 1,000,000
Taxes (40%) 400,000
EBIT(1 – T) $ 600,000
Add back depreciation 2,000,000
Project cash flow = EBIT(1 – T) + DEP $ 2,600,000

b. The cannibalization of existing sales needs to be considered in this analysis on an after-tax basis, because the
cannibalized sales represent sales revenue the firm would realize without the new project but would lose if the
new project is accepted.

The after-tax effect would reduce the project’s cash flow by:
$1,000,000(1 – T) = $1,000,000(0.6) = $600,000.

The project’s cash flow would now be $2,000,000 rather than $2,600,000.

Q2) Equipment’s original cost $20,000,000


Depreciation (80%) 16,000,000
Book value $ 4,000,000

Gain on sale = $5,000,000 – $4,000,000 = $1,000,000.


Tax on gain = $1,000,000(0.4) = $400,000.
AT salvage value = $5,000,000 – $400,000 = $4,600,000.

Q3) a. The $5,000 spent last year on exploring the feasibility of the project is a sunk cost and should not be
included in the analysis.

b. The initial investment outlay at t = 0 is $126,000:


Price ($108,000)
Modification (12,500)
CAPEX ($120,500)
NOWC (5,500)
Initial investment outlay ($126,000)

CF0 = -$126,000.
c. The annual project cash flows follow:
Project’s operating cash flows:
Year 1 Year 2 Year 3  
Savings $44,000 $44,000 $44,000
Depreciation 39,765 54,225 18,075
EBIT $ 4,235 ($10,225) $25,925
Taxes (35%) 1,482 (3,579) 9,074
EBIT(1 – T) $ 2,753 ($ 6,646) $16,851
Add Depreciation 39,765 54,225 18,075
EBIT(1 –T) + DEP $42,518 $47,579 $34,926

Terminal cash flows at time = 3:


Salvage value $65,000
Tax on salvage value 19,798
AT salvage value $45,202
NOWC = Recovery of NOWC 5,500
Project FCFs = EBIT(1 – T)
+ DEP – CAPEX – NOWC $42,518 $47,579 $85,628

(BV in Year 4 = $120,500(0.07) = $8,435.


Tax on SV = ($65,000 – $8,435)(0.35) = $19,798.)

d. The project has an NPV of $10,841; thus, it should be accepted.

Examples
Q1)
NPV = $78.82 IRR = 14.489%

MIRR:
Terminal value = NFV
CF0 = 0; CF1 = 500; CF2 = 400; CF3 = 300; CF4 = 100; I = 10%; NFV = $1579.5

PV of cost = -$1,000

N = 4; PV = -1000; FV = 1579.5; I = MIRR = 12.106%.

Payback:
0 1 2 3 4
| | | | |
-1,000 500 400 300 100
Cumulative CF: -1,000 -500 -100 200 300

Payback = 2 + $100/$300 = 2.33 years.

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