1. Calculate the present value of each of the following cash flow streams.

Use a discount
rate of 10%.
a. $500 received at the end of five years.
b. $500 received annually for each of the next five years.
c. $500 received annually for each of the next fifty years.
d. $500 received annually for 100 years.

2. Singular Construction is evaluating whether to build a new distribution facility. The

proposed investment will cost Singular $4 million to construct and provide cash savings
of $500,000 per year over the next ten years.
a. What rate of return does the investment offer?
b. If Singular were to invest another $200,000 in the facility at the end of five years, it
would extend the life of the project by four years, during which time it would continue
receiving cash savings of $500,000. What is the internal rate of return for this investment?

3. In the spring of 2015, Jemison Electric was considering an investment in a new

distribution center. Jemison's CFO anticipates additional earnings before interest and
taxes (EBIT) of $100,000 for the first year of operation of the center, and, over the next
five years, the firm estimates that this amount will grow at a rate of 5% per year. The
distribution center will require an initial investment of $400,000 that will be depreciated
over a five-year period toward a zero-salvage value using straight-line depreciation of
$80,000 per year. Jemison's CFO estimates that the distribution center will need operating
net working capital equal to 20% of EBIT to support operation.
Assuming the firm faces a 30% tax rate, calculate the project's annual project free cash
flows (FCFs) for each of the next five years where the salvage value of operating
networking capital and fixed assets is assumed to equal their book values, respectively.

4. In the JC Crawford example, capital expenditures (CAPEX) are estimated using projected
balances for net property, plant, and equipment (net PPE), which is determined by the
firm's projected sales. In 2016, the estimated ending balance for net PPE is projected to be
$440,000, which represents an increase of $40,000 over the ending balance for 2015.
However, CAPEX for 2016 is estimated to be $80,000. Why is the change in net PPE not
equal to CAPEX? (Hint: Consider the effect of annual depreciation expense on net PPE.)

5. The free cash flow estimated for 2008 in the Lecion example was equal to
$1,383,436,000. Verify this computation using the assumptions underlying the model.
Compute the free cash flow for 2008 if the revenues for the year were 10% higher than
those forecast in the table 1:
Table 1: Market Demand and Revenue Projections for Lecion's LCD
Fabricating Plant
Year Projected Lecion's Sale Price per Lecions's
Total Unit Sales Unit Revenue
Market (000) Forecast (000)
Unit Sales
(000)
2004 10,000 2,000 $8,000 $16,000,000
2005 15,000 3,000 5,959 17,877,676
 2006 20,000 4,000 4,932 19,727,751
2007 20,000 4,000 4,381 17,525,479
2008 15,000 3,000 4,098 12,294,285

6. Petroleum Corporation is an integrated oil company headquartered in Fort Worth, Texas.

Historical income statements for 2014 and 2015 are found below (dollar figures are in the
millions):
Dec-15 Dec-14
Sales $13,368 $12,211
Cost of Goods sold (10,591) (9,755)
Gross Profit 2777 2,456
Selling, general, and administrative
(698) (704)
expense
Operating income before depreciation 2,079.00 1,752.00
Depreciation, depletion, and
(871) (794)
amortization
Operating profit 1,208.00 958
Interest expense (295) (265)
Nonoperating income or expense 151 139
Special items 20
Pretax income 1,064.00 852
Taxes (425.6) (340.8)
Net income $638.4 $ 511.20
In 2014, TCM made capital expenditures of $875 million, followed by $1,322 million in
2015. TCM also invested an additional $102 million in net working capital in 2014, fol-
lowed by a decrease in its investment in net working capital of $430 million in 2015.
a. Calculate TCM's FCFs for 2014 and 2015. TCM's tax rate is 40%.
b. Estimate TCM's FCFs for 2016 to 2020 using the following assumptions: Operating in-
come continues to grow at 10% per year over the next five years, CAPEX is expected to
be $1,000 million per year, new investments in net working capital are expected to be
$100 million per year, and depreciation expense equals the prior year's total plus 10% of
the prior year's CAPEX. Note that because TCM is a going concern, we need not be
concerned about the liquidation value of the firm's assets at the end of 2020.

7. Steve's Sub Stop (Steve's) is considering invest- ing in toaster ovens for each of its 120
stores located in the southwestern United States. The high-capacity conveyor toaster
ovens, manufactured by Lincoln, will require an initial investment of $15,000 per store
plus $500 in installation costs, for a total investment of $1,860,000. The new capital
(including the costs for installation) will be depreciated over five years using straight-line
depreciation toward a zero-salvage value. Steve's will also incur additional maintenance
expenses totaling $120,000 per year to maintain the ovens. At present, firm revenues for
the 120 stores total $9 million, and the company estimates that adding the toaster feature
will increase revenues by 10%.
a. If Steve's faces a 30% tax rate, what expected project FCFs for each of the next five
years will result from the investment in toaster ovens?
 b. If Steve's uses a 9% discount rate to analyze its investments in its stores, what is the
project's NPV? Should the project be accepted?

8. South Tel Communications is considering the purchase of a new software management

system. The system is called B-Image, and it is expected to reduce drastically the amount
of time that company technicians spend installing new software. South Tel's technicians
currently spend 6,000 hours per year on installations, which costs South Tel $25 per hour.
The owners of the B-Image system claim that their software can reduce time on task by at
least 25%. The system requires an initial investment of $55,000 and an additional
investment of $10,000 for technician training on the new system. Annual upgrades will
cost the firm $15,000 per year. The tax treatment of software purchases sometimes calls
for amortization of the initial cost over time; sometimes the cost can be expensed in the
year of the purchase. Before the tax experts are consulted and for purposes of this initial
analysis, South Tel has decided that it will expense the cost of the software in the year of
the expenditure. South Tel faces a 30% tax rate and uses a 9% cost of capital to evaluate
projects of this type.
a. Assume that South Tel has sufficient taxable income from other projects so that it can
expense the cost of the software immediately. What are the free cash flows for the project
for years zero through five?
b. Calculate the NPV and IRR for the project.

9. The CT Computers Corporation is considering whether to begin offering customers the

option to have their old personal computers (PCS) recycled when they purchase new
systems. The recycling system would require CT Computers to invest $600,000 in the
grinders and magnets used in the recycling process. The company estimates that for each
system it recycles, it would generate $1.50 in incremental revenues from the sale of scrap
metal and plastics. The machinery has a five-year useful life and will be depreciated using
straight-line depreciation toward a zero-salvage value. CT Computers estimates that in the
first year of the recycling investment, it could recycle 100,000 PCs and that this number
will grow by 25% per year over the remaining four-year life of the recycling equipment.
CT Computers uses a 15% discount rate to analyze capital expenditures and pays taxes
equal to 30%.
a. What are the project cash flows? You can assume that the recycled PCs cost CT
Computers nothing.
b. Calculate the NPV and IRR for the recycling investment opportunity. Is the investment
a good one based on these cash flow estimates?
c. Is the investment still a good one if only 75,000 units are recycled in the first year?
d. Redo your analysis for a scenario in which CT Computers incurs a cost of $0.20 per
unit to dispose of the toxic elements from the recycled computers. What is your
recommendation under these circumstances?

10. Glentech Manufacturing is considering the purchase of an automated parts handler for
the assembly and test area of its Phoenix, Arizona, plant. The handler will cost $250,000
to purchase plus $10,000 for installation. If the company undertakes the investment, it
will automate part of the semiconductor test area and reduce operating costs by $70,000
per year for the next ten years. Five years into the life of the investment, however,
 Glentech will have to spend an additional $100,000 to update and refurbish the handler.
The investment in the handler will be depreciated using straight-line depreciation over ten
years, and the refurbishing costs will be depreciated over the remaining five-year life of
the handler (also using straight-line depreciation). In ten years, the handler is expected to
be worth $5,000, although its book value will be zero. Glentech's tax rate is 30%, and its
opportunity cost of capital is 12%. Table 2 contains cash flow calculations for the project
that can be used in performing a DCF evaluation of its contribution to firm value.
Table 2: Glentech Manufacturing Company Cash Flow Estimates

0 1 2 3 4 5 6 7 8 9 10
Investment
Outlays
Equipment (2,50,000) (1,00,000)
purchases
Installation (10,000)
costs
Initial outlay (2,60,000)
After-tax 3,500
salvage value
Free Cash
Flows
Operating exp. 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000
savings
Less: (26000) (26000) (26000) (26000) (26000) (46,000) (46,000) (46,000) (46,000) (46,000)
Depreciation
exp.
Added oper. 44,000 44,000 44,000 44,000 44,000 24,000 24,000 24,000 24,000 24,000
income
Less: Taxes 13,200 13,200 13,200 13,200 13,200 7,200 7,200 7,200 7,200 7,200
NOPAT 30,800 30,800 30,800 30,800 30,800 16,800 16,800 16,800 16,800 16,800
Plus: 26,000 26,000 26,000 26,000 26,000 46,000 46,000 46,000 46,000 46,000
Depreciation
Less: CAPEX (2,60,000) (1,00,000)
Free cash flow (260000) 56800 56800 56800 56800 (43200) 62800 62800 62800 62800 66300
 Answer each of the following questions concerning the project:
a. Is this a good project for Glentech? Explain your answer.
b. What can you tell about the project from the NPV profile found in the given Graph?
c. If the project were partially financed by borrowing, how would this affect the invest-
ment cash flows? How would borrowing a portion of the investment outlay affect the
value of the investment to the firm?
d. The project calls for two investments: one immediately and one at the end of year 5.
How much would Glentech earn on its investment? How should you account for the
additional investment outlay in your calculations?
e. What are the considerations that make this investment somewhat risky? How would
you investigate the potential risks of this investment?

11. Corporation is considering the manufacture of a new chemical compound that is used to
make high-pressure plastic containers. An investment of $4 million in plant and
equipment is required. The firm estimates that the investment will have a five-year life
and will use straight-line depreciation toward a zero salvage value. However, the
investment has an anticipated salvage value equal to 10% of its original cost. The number
of pounds (in millions) of the chemical compound that HMG expects to sell over the five-
year life of the project are as follows: 1.0, 1.5, 3.0, 3.5, and 2.0. To operate the new plant,
HMG estimates that it will incur additional fixed cash operating expenses of $1 million
per year and variable operating expenses equal to 45% of revenues. HMG also estimates
that in year it will need to invest 10% of the anticipated increase in revenues for year 1+1
in net working capital. The price per pound for the new compound is expected to be $2.00
in years 1 and 2, then $2.50 per pound in years 3 through 5. HMG's tax rate is 38%, and it
requires a 15% rate of return on its new-product investments.
a. Table 3 contains projected cash flows for the entire life of the proposed investment.
Note that investment cash flow is derived from the additional revenues and costs
associated with the proposed investment. Verify the calculation of project cash flow for
year 5.
b. Does this project create shareholder value? How much? Should HMG undertake the
investment? Explain your answer.
c. What if the estimate of the variable costs were to rise to 55%? Would this affect your
decision?
Table 3: HMG Project Analysis
Given:
Investment 40,00,000
Plant life 5
Salvage value 4,00,000
Variable cost% 45%
Fixed operating cost 10,00,000
Tax rate 38%
10% of the change in revenues for the
Working capital year
Required rate of
return 15%

0 1 2 3 4 5
Sales volume 10,00,000 15,00,000 30,00,000 35,00,000 20,00,000
Unit price 2 2 2.5 2.5 2.5
Revenues 20,00,000 30,00,000 75,00,000 87,50,000 50,00,000
Variable operating costs -900000 -1350000 -3375000 -3375000 -2250000
-
Fixed operating costs 10,00,000 -10,00,000 -10,00,000 -10,00,000 -10,00,000
Depreciation expense -8,00,000 -8,00,000 -8,00,000 -8,00,000 -8,00,000
Net operating income -7,00,000 -1,50,000 23,25,000 30,12,500 9,50,000
Less: Taxes 2,60,000 57,000 -8,83,500 -11,44,750 -3,61,000
NOPAT -4,34,000 -93,000 14,41,500 18,67,750 5,89,000
Plus: Depreciation 8,00,000 8,00,000 8,00,000 8,00,000 8,00,000
-
Less: CAPEX 40,00,000 2,48,000
Less: Working - -
capital 2,00,000 1,00,000 -1,25,000 -4,50,000 3,75,000 5,00,000
Free cash flow -4200000 266000 2116500 257000 3042750 2137000
Net present value 4,19,435
Internal rate of
return 18.01%

12. Carson Electronics is currently considering whether to ac- quire a new materials-handling
machine for its manufacturing operations. The machine costs $760,000 and will be
depreciated using straight-line depreciation toward a zero-salvage value over the next five
years. During the life of the machine, no new capital expenditures, or investments in
working capital will be required. The new materials-handling machine is expected to save
Carson Electronics $250,000 per year before taxes of 30%. Carson's CFO recently
analyzed the firm's opportunity cost of capital and estimated it to be 9%.
a. What are the annual free cash flows for the project?
b. What are the project's NPV and IRR? Should Carson Electronics accept the project?
13. Carson's new head of manufacturing was concerned about whether the new handler could
deliver the promised savings. In fact, he projected that the savings might be 20% lower
than projected. What are the NPV and IRR for the project under this scenario?
At the end of 2013, the executives at Apple evaluated a number of competitive
threats to their very profitable iPhone business and decided that the iPhone 6 would need
to exhibit some fundamental improvements. For example, they considered an increase in
screen size, possibly to 5.5 inches, and a Bluetooth, connection to an accompanying
watch, which would display incoming emails and texts along with the number of
incoming calls.
 Apple estimates that the more aggressive product launch will require a
development budget of $1.5 billion versus $800 million for a more modest effort. Discuss
how you would estimate the incremental cash flows associated with this decision. To
answer this question, consider both the Frito Lay and Lecion examples in the chapter.
(Hint: There are no calculations involved; simply describe how you would approach the
forecasting problem Apple faces.)