Relevant Cash Flows Cheesy Poofs, Inc., is looking at setting up a new manufacturing plant in South Park to produce Cheesy Poofs. The company bought some land six years ago for $5 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. The land was appraised last week for $4.2 million. The company wants to build its new manufacturing plant on this land; the plant will cost $7.3 million to build, and the site requires $325,000 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? Relevant Cash Flows Winnebagel Corp. currently sells 20,000 motor homes per year at $45,000 each, and 8,000 luxury motor coaches per year at $78,000 each. The company wants to introduce a new portable camper to fill out its product line; it hopes to sell 16,000 of these campers per year at $12,000 each. An independent consultant has determined that if Winnebagel introduces the new campers, it should boost the sales of its existing motor homes by 5,000 units per year, and reduce the sales of its motor coaches by 1,000 units per year. What is the amount to use as the annual sales figure when evaluating this project? Why? Calculating Projected Net Income A proposed new investment has projected sales of $700,000. Variable costs are 60 percent of sales, and fixed costs are $175,000; depreciation is $75,000. Prepare a pro forma income statement assuming a tax rate of 35 percent. What is the projected net income?

Calculating OCF

Sales Costs

Depreciation EBIT

Taxes (34%) Net income

Consider the following income statement:

$864,350 501,500 112,000

Fill in the missing numbers and then calculate the OCF. What is the depreciation tax shield?

OCF from Several Approaches A proposed new project has projected sales of $85,000, costs of $43,000, and depreciation of $3,000. 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. Calculating Depreciation A piece of newly purchased industrial equipment costs $847,000 and is classified as seven-year property under MACRS. Calculate the annual depreciation allowances and end-of-the-year book values for this equipment.

Calculating Salvage Value Consider an asset that costs $320,000 and is depreciated straight-line to zero over its eight-year tax life. The asset is to be used in a five-year project; at the end of the project, the asset can be sold for $70,000. If the relevant tax rate is 35 percent, what is the aftertax cash flow from the sale of this asset?

Calculating Salvage Value An asset used in a four-year project falls in the five-year MACRS class for tax purposes. The asset has an acquisition cost of

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

IV. Capital Budgeting

10. Making Capital Investment Decisions

© The McGraw-Hill Companies, 2002

CHAPTER 10 Making Capital Investment Decisions

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