DISCOUNTED CASH FLOW ANALYSIS FOR INVESTMENT DECISIONS

DISCOUNTED CASH FLOW ANALYSIS FOR INVESTMENT DECISIONS

- APPLICATIONS -

1. Canyon Tours

Canyon Tours showed the following components of working capital last year:

a)      What was the change in net working capital during the year?

b)      If sales were 36,000 and costs were 24,000, what was cash flow for the year? Ignore taxes.

2. ABC Co.

The following table tracks the main components of working capital over the life of a four-year project developed by ABC Co.

Calculate net working capital and the cash inflows and outflows due to investment in working capital.

3. Masters Golf Products, Inc.

Masters Gold Products, Inc., spent 3 years and $1,000,000 to develop its new line of club heads to replace a line that is becoming obsolete. In order to begin manufacturing them, the company will have to invest $1,800,000 in new equipment. The new clubs are expected to generate an increase in operating cash inflows of $750,000 per year for the next 10 years. The company has determined that the existing line could be sold to a competitor for $250,000.

(a)    How should the $1,000,000 in development costs be classified?

(b)   How should the $250,000 sale price for the existing line be classified?

(c)    Depict all of the known relevant cash flows on a time line.

4. Molecugen

Molecugen has developed a new kind of cardiac diagnostic unit. Owing to the highly competitive nature of the market, the sales department forecasts demand of 5,000 units in the first year and a decrease in demand of 10 percent a year after that. After five years, the project will be discontinued with no salvage value. The marketing department forecasts a sales price of $15 a unit. Production estimates operating cost of $5 a unit, and the finance department estimates general and administrative expenses of $15,000 a year. The initial investment in land is $10,000, and other non-depreciable setup costs are $10,000.

Is the new project acceptable at a cost of capital of 10 percent? (Note: Use straight-line depreciation over the life of the project and a tax rate of 35 percent.)

5. Gates Hardware (A)

Gates Hardware Inc. (GHI) is considering an investment of $5 million in plant and machinery. This is expected to produce sales of $2 million in year 1, $4 million in year 2, and $6 million in year 3. Subsequent sales will increase at the expected inflation rate of 10%. The plant is expected to be scrapped after 6 years with a salvage value of $1 million. It is depreciated for tax purposes on a straight-line basis of $1 million per year. Operating costs are expected to be 70% of the sales. Working capital requirements are negligible. GHI pays tax at 35%. Calculate the expected cash flows in each year and the NPV of the investment when the required rate of return is 16%.

6. Gates Hardware (B)

Repeat the calculation of the previous problem, doing the analysis in real instead of nominal terms.

7. Star Co.

Star Co. is considering the acquisition of production equipment, which will reduce both labor and materials costs. The cost is $100,000 and it will be depreciated on a straight-line basis over a four-year period. However, the useful life of the equipment is five years, and it will have a $20,000 salvage value at the end of five years. Operating costs will be reduced by $30,000 in the first year, and the savings will increase by $5,000 per year for years 2, 3 and 4. Due to increased maintenance costs, savings in year 5 will be $10,000 less than the year 4 savings. The equipment will also generate savings in net working capital of $5,000, starting of year 848e412i 0, which will cease at the end of the fifth year of the project. The firm's tax rate is 34% and the firm requires a 16% return. Compute the cash flows for the project for years 0 through 5. Would you accept the project, given its required return?

8. Mouw Co.

Mouw Co. is considering the purchase of either Machine X or Machine Y. The two machines provide the same benefit to the company and the machine selected will be replaced at the end of its useful life. The lives and annual costs for each are:

The opportunity cost of capital is 15%. Given no taxes, which machine should be selected?