FIN922 –Corporate Finance –
Tutorial
Dr. Kashif Saleem
E-mail:
[email protected] Office: Room 105, 1st floor
5-1
Relevant Cash Flows
Parker & Stone, Inc., is looking at setting up a new manufacturing plant in South Park
to produce garden tools. The company bought some land six years ago for $6 million
in anticipation of using it as a warehouse and distribution site, but the company has
since decided to rent these facilities from a competitor instead. If the land were sold
today, the company would net $6.4 million. The company wants to build its new
manufacturing plant on this land; the plant will cost $14.2 million to build, and the site
requires $890,000 worth of grading before it is suitable for construction.
What is the proper cash flow amount to use as the initial investment in fixed assets
when evaluating this project?
Why?
6-2
Calculating OCF
Consider the following income statement:
Fill in the missing numbers and then calculate the OCF.
What is the depreciation tax shield?
6-3
OCF from Several Approaches
A proposed new project has projected sales of $108,000, costs of $51,000, and
depreciation of $6,800. The tax rate is 35 percent.
Calculate operating cash flow using the four different approaches described in the
chapter and verify that the answer is the same in each case.
6-4
Calculating Project OCF
Summer Tyme, Inc., is considering a new three year expansion project that requires
an initial fixed asset investment of $3.9 million. The fixed asset will be depreciated
straight-line to zero over its three-year tax life, after which time it will be worthless.
The project is estimated to generate $2,650,000 in annual sales, with costs of
$840,000. If the tax rate is 35 percent,
what is the OCF for this project?
6-5
Calculating Project Cash Flow from Assets
In the previous problem, suppose the project requires an initial investment in net
working capital of $300,000, and the fixed asset will have a market value of
$210,000 at the end of the project.
What is the project’s year 0 net cash flow?
Year 1?
Year 2?
Year 3?
What is the new NPV?
6-6
Calculating EAC
You are evaluating two different silicon wafer milling machines. The Techron I costs
$290,000, has a three-year life, and has pretax operating costs of $67,000 per year. The
Techron II costs $510,000, has a five-year life, and has pretax operating costs of
$35,000 per year. For both milling machines, use straight-line depreciation to zero over
the project’s life and assume a salvage value of $40,000. If your tax rate is 35 percent
and your discount rate is 10 percent,
compute the EAC for both machines.
Which do you prefer?
Why?
6-7
Cost-Cutting Proposals
Geary Machine Shop is considering a four-year project to improve its production
efficiency. Buying a new machine press for $560,000 is estimated to result in
$210,000 in annual pretax cost savings. The press falls in the MACRS five-year class,
and it will have a salvage value at the end of the project of $80,000. The press also
requires an initial investment in spare parts inventory of $20,000, along with an
additional $3,000 in inventory for each succeeding year of the project. If
the shop’s tax rate is 35 percent and its discount rate is 9 percent,
MACRS Rates: 20%, 32%, 19.20%, 11.52%
should the company buy and install the machine press?
6-8
