T3 tutorial questions PDF

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TOPIC 3 REQUIRED READING Ch6 & Ch7.1& Ch7.2 Ch4 & Ch5 are assumed knowledge TUTORIAL EXERCISES 1. Text, Ch 6, conceptual question 2; Incremental Cash Flows Which of the following should be treated as an incremental cash flow when computing the NPV of an investment? a. A reduction in the sales of a company's other products caused by the investment. b. An expenditure on plant and equipment that has not yet been made and will be made only if the project is accepted. c. Costs of research and development undertaken in connection with the product during the past three years. d. Annual depreciation expense from the investment. e. Dividend payments by the firm. f. The resale value of plant and equipment at the end of the project's life. g. Salary and medical costs for production personnel who will be employed only if the project is accepted.

2. Text, Ch 6, problems 2, 15, 29 & 30 ; 2. Calculating Project NPV The Best Manufacturing Company is considering a new investment. Financial projections for the investment are tabulated here. The corporate tax rate is 34 percent. Assume all sales revenue is received in cash, all operating costs and income taxes are paid in cash, and all cash flows occur at the end of the year. All net working capital is recovered at the end of the project. Year 0 Year 1 Year 2 Year 3 Year 4 $ Investment 27,400 Sales revenue 12,900 14,000 15,200 11,200 Operating costs 2,700 2,800 2,900 2,100 Depreciation 6,850 6,850 6,850 6,850 Net working capital 300 200 225 150 ? spending a. Compute the incremental net income of the investment for each year. b. Compute the incremental cash flows of the investment for each year. c. Suppose the appropriate discount rate is 12 percent. What is the NPV of the project? 15. Capital Budgeting with Inflation Consider the following cash flows on two mutually exclusive projects:

Year Project A Project B 0 -$ 30,000 -$ 45,000 1 18,000 21,000 2 16,000 23,000 3 12,000 25,000 The cash flows of project A are expressed in real terms, whereas those of project B are expressed in nominal terms. The appropriate nominal discount rate is 13 percent and the inflation rate is 4 percent. Which project should you choose?

29. Calculating Required Savings A proposed cost-saving device has an installed cost of $710,000. The device will be used in a five-year project but is classified as three-year MACRS property for tax purposes. The required initial net working capital investment is $65,000, the marginal tax rate is 35 percent, and the project discount rate is 12 percent. The device has an estimated Year 5 salvage value of $60,000. What level of pretax cost savings do we require for this project to be profitable?

30. Calculating a Bid Price Another utilization of cash flow analysis is setting the bid price on a project. To calculate the bid price, we set the project NPV equal to zero and find the required price. Thus the bid price represents a financial breakeven level for the project. Guthrie Enterprises needs someone to supply it with 165,000 cartons of machine screws per year to support its manufacturing needs over the next five years, and you've decided to bid on the contract. It will cost you $2,300,000 to install the equipment necessary to start production; you'll depreciate this cost straight-line to zero over the project's life. You estimate that in five years this equipment can be salvaged for $150,000. Your fixed production costs will be $450,000 per year, and your variable production costs should be $9.25 per carton. You also need an initial investment in net working capital of $130,000. If your tax rate is 35 percent and you require a 14 percent return on your investment, what bid price should you submit?

3. Text, Ch 7, conceptual questions 5 & 8 ; 5. Break-Even Point Assume a firm is considering a new typical project that requires an initial investment with sales, variable costs and fixed costs over its life. Will the project usually reach the accounting, cash, or financial break-even point first? Which will it reach next? Last? Will this order always apply? 8. Sensitivity and Break-even Analysis How does sensitivity analysis interact with break-even analysis?

4. Text, Ch 7, problems 9. 26 & 27. 9. Financial Break-even Analysis You are considering investing in a company that cultivates abalone for sale to local restaurants. Use the following information:

Sales price per abalone Variable costs per abalone Fixed costs per year Depreciation per year Tax rate

=$39 =$7.15 =$410,000 =$120,000 =35%

The discount rate for the company is 15 percent, the initial investment in equipment is $840,000, and the project's economic life is seven years. Assume the equipment is depreciated on a straight-line basis over the project's life. 1. What is the accounting break-even level for the project? 2. What is the financial break-even level for the project? 26. Scenario Analysis Consider a project to supply Detroit with 25,000 tons of machine screws annually for automobile production. You will need an initial $2,700,000 investment in threading equipment to get the project started; the project will last for five years. The accounting department estimates that annual fixed costs will be $275,000 and that variable costs should be $265 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the five-year project life. It also estimates a salvage value of $250,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $345 per ton. The engineering department estimates you will need an initial net working capital investment of $400,000. You require a 13 percent return and face a marginal tax rate of 38 percent on this project. a. What is the estimated OCF for this project? The NPV? Should you pursue this project? b. Suppose you believe that the accounting department's initial cost and salvage value projections are accurate only to within ±15 percent; the marketing department's price estimate is accurate only to within ±10 percent; and the engineering department's net working capital estimate is accurate only to within ±5 percent. What is your worst-case scenario for this project? Your best-case scenario? Do you still want to pursue the project? 27. Sensitivity Analysis In Problem 26, suppose you're confident about your own projections, but you're a little unsure about Detroit's actual machine screw requirements. What is the sensitivity of the project OCF to changes in the quantity supplied? What about the sensitivity of NPV to changes in quantity supplied? Given the sensitivity number you calculated, is there some minimum level of output below which you wouldn't want to operate? Why?...