ACME Manufacturing is considering replacing an existing production line with a new line that has a greater output capacity and operates with less labor than the existing line. The new line would cost $1 million, have a five-year life, and be depreciated using MACRS over three years. At the end of five years, the new line could be sold as scrap for $200,000 (in Year 5 dollars). Because the new line is more automated, it would require fewer operators, resulting in a savings of $40,000 per year before tax and unadjusted for inflation (in today’s dollars). Additional sales with the new machine are expected to result in additional net cash inflows, before tax, of $60,000 per year (in today’s dollars). If ACME invests in the new line, a one-time investment of $10,000 in additional working capital will be required. The tax rate is 35 percent, the opportunity cost of capital is 10 percent, and the annual rate of inflation is 3 percent. What is the NPV of the new production line?
> Explain why the total value of all of the securities used to finance a firm must be equal to the value of the firm?
> Describe the alternatives to using a firm’s WACC as a discount rate when evaluating a project?
> KneeMan Markup Company has total debt obligations with book and market values equal to $30 million and $28 million, respectively. It also has total equity with book and market values equal to $20 million and $70 million, respectively. If you were going t
> Why is the per-unit contribution important in a break-even analysis?
> Caterpillar, Inc. is a manufacturer of large earth-moving and mining equipment. This firm, and other heavy equipment manufacturers, have accounting degrees of operating leverage that are relatively high. Explain why?
> The degree of pretax cash flow operating leverage at Rackit Corporation is 2.7 when it sells 100,000 units of its new tennis racket and its EBITDA is $95,000. Ignoring the effects of taxes, what are the fixed costs for Rackit Corporation?
> WalkAbout Kangaroo Shoe Stores forecasts that it will sell 9,500 pairs of shoes next year. The firm buys its shoes for $50 per pair from the wholesaler and sells them for $75 per pair. If the firm will incur fixed costs plus depreciation and amortization
> The Fulcrum Company produces decorative swivel platforms for home televisions. If Fulcrum produces 40 million units, it estimates that it can sell them for $100 each. The variable production costs are $65 per unit, whereas the fixed production costs are
> Commodore Motors management is considering a project to produce toy cars. The project would require an initial outlay of $100,000 and have an expected life of 10 years. Management estimates that each year during the life of the project depreciation and
> How is the per-unit contribution related to the accounting operating profit break-even point?
> You are the project manager for Eagle Golf Corporation. You are considering manufacturing a new golf wedge with a unique groove design. You have put together the estimates in the following table about the potential demand for the new club, and the asso
> Using the same logic as with the accounting break-even calculation in Problem 12.19, adapt the formula for crossover level of unit sales to find the number of units sold where the pretax operating cash flow is the same whether the firm chooses the large
> If a firm’s costs (both variable as well as fixed) are known with certainty, then what are the only two sources of volatility for the firm’s operating profits or its operating cash flows?
> Silver Polygon, Inc., has determined that if its revenues were to increase by 10 percent, then EBIT would increase by 25 percent to $100,000. The fixed costs (cash only) for the firm are $100,000. Given the same 10 percent increase in revenues, what woul
> If a firm has a fixed asset base, meaning that its depreciation and amortization for any year is positive, discuss the relation between its Accounting DOL and its Cash flow DOL?
> The Generic Publications Textbook Company sells all of its books for $100 per book, and it currently costs $50 in variable costs to produce each text. The fixed costs, which include depreciation and amortization for the firm, are currently $2 million per
> Mick’s Soft Lemonade is starting to develop a new product for which the cash fixed costs are expected to be $80,000. The projected EBIT is $100,000, and the Accounting DOL is expected to be 2.0. What is the Cash Flow DOL for the firm?
> If you were interested in calculating the probability that your project will have a positive FCF, what type of risk analysis tool will you most likely use?
> Chip’s Home Brew Whiskey management forecasts that if the firm sells each bottle of Snake-Bite for $20, then the demand for the product will be 15,000 bottles per year, whereas sales will be 90 percent as high if the price is raised 10 percent. Chip’s v
> Describe the circumstances under which sensitivity analysis might be a reasonable basis for determining changes to a firm’s EBIT or FCF?
> What is the difference between the pretax operating cash flow break-even point and the accounting operating profit break-even point?
> Sensitivity analysis and scenario analysis are somewhat similar. Describe which is a more realistic method of analyzing the impact of different scenarios on a project?
> The BowGus Archery Company management estimates that its new Galactically Flexible Bow project will have to generate EBIT of $20,000 each year to be viable. The project’s fixed cash expenses are expected to equal $8,000 and its depreciation and amortizat
> RoseWeiser Company Management is considering a project that will require an initial investment of $50,000 and will last for 10 years. No other capital expenditures or increases in working capital are anticipated during the life of the project. What is
> Management of March and Dine Inc. has estimated that the firm’s new TV dinner project must generate $10,200 in FCF during each of the next six years to have an NPV of $0. Management anticipates that depreciation and amortization charges will equal $3,00
> Your analysis tells you that at a projected level of sales, a project your firm is considering will be below accounting break-even but above cash flow break-even. Explain why this might still be a viable project for your firm?
> Calculate the pretax operating cash flow break-even point for both factory choices for Dandle’s Candles? Use the following information below: Dandle’s Candles will be producing a new line of dripless candles in the coming years and has the choice of pro
> Describe the role that the mix of variable versus fixed costs has in the variation of earnings before interest and taxes (EBIT) for the firm?
> Calculate the number of candles for which the accounting operating profit at Dandle's Candles is the same regardless of the factory choice? Use the following information below: Dandle’s Candles will be producing a new line of dripless candles in the com
> Calculate the accounting operating profit break-even point for both factory choices for Dandle’s Candles? Use the following information below: Dandle’s Candles will be producing a new line of dripless candles in the coming years and has the choice of pr
> For the Vinyl CD Co. in Self-Study Problem 12.3, what percentage increase in pretax operating cash flow will be driven by the additional revenue?
> What do the degree of pretax cash flow operating leverage (Cash Flow DOL) and the degree of accounting operating leverage (Accounting DOL) tell us?
> The pretax operating cash flow of Memphis Motors declined so much during the recession of 2008 and 2009 that the company almost defaulted on its debt. The owner of the company wants to change the cost structure of his business so that this does not happe
> Specialty Light Bulbs anticipates selling 3,000 light bulbs this year at a price of $15 per bulb. It costs Specialty $10 in variable costs to produce each light bulb, and the fixed costs for the firm are $10,000. Specialty has an opportunity to sell an a
> Duplicate Footballs, Inc., expects to sell 15,000 balls this year. The balls sell for $110 each and have a variable cost per unit of $80. Fixed costs, including depreciation and amortization, are currently $220,000 per year. How much can either the fixed
> What is simulation analysis, and how is it used?
> The accounting operating profit break-even point tells us the number of units that must be sold for a firm to break-even in a given year from an accounting operating profit perspective. What measure tells us the number of units that must be sold each yea
> Calculate the accounting operating profit break-even point and pretax operating cash flow break-even point for each of the three production choices outlined below?
> Define variable costs and fixed costs, and give an example of each?
> Zippy Corporation just purchased computing equipment for $20,000. The equipment will be depreciated using a five-year MACRS depreciation schedule. If the equipment is sold at the end of its fourth year for $12,000, what are the after-tax proceeds from th
> When forecasting operating expenses, explain the difference between a fixed cost and a variable cost?
> What are variable costs and fixed costs? What are some examples of each? How are these costs estimated in forecasting operating expenses?
> Why do analysts care about how sensitive EBITDA and EBIT are to changes in revenue?
> Healthy Potions, Inc., a pharmaceutical company, bought a machine at a cost of $2 million five years ago that produces pain-reliever medicine. The machine has been depreciated over the past five years, and the current book value is $800,000. The company
> What is the difference between average tax rate and the marginal tax rate? Which one should we use in calculating incremental after-tax cash flows?
> What is the difference between nominal and real cash flows? Which rate of return should we use to discount each type of cash flow?
> After estimating a project’s NPV, the analyst is advised that the fixed capital outlay will be revised upward by $100,000. The fixed capital outlay is depreciated straight-line over an eight-year life. The tax rate is 40 percent, and the required rate of
> FITCO is considering the purchase of new equipment. The equipment costs $350,000, and an additional $110,000 is needed to install it. The equipment will be depreciated straight-line to zero over a five-year life. The equipment will generate additional an
> The alternative to investing in the new production line in Problem 11.36 is to overhaul the existing line, which currently has both a book value and a salvage value of $0. It would cost $300,000 to overhaul the existing line, but this expenditure would e
> Biotech Partners LLC has been farming a new strain of radioactive-material-eating bacteria that the electrical utility industry can use to help dispose of its nuclear waste. Two opposing factors affect Biotech’s decision of when to harvest the bacteria.
> Great Fit, Inc., is a company that manufactures clothing. The company has a production line that produces women’s tops of regular sizes. The same machine could be used to produce petite sizes as well. However, the remaining life of the machines will be r
> A beauty product company is developing a new fragrance named Happy Forever. There is a probability of 0.5 that consumers will love Happy Forever, and in this case, annual sales will be 1 million bottles; a probability of 0.4 that consumers will find the
> How do we decide when to harvest an asset?
> List the major stock market indexes, and explain what they tell us?
> Rocky Mountain Lumber, Inc., is considering purchasing a new wood saw that costs $50,000. The saw will generate revenues of $100,000 per year for five years. The cost of materials and labor needed to generate these revenues will total $60,000 per year, a
> Merton Shovel Corporation has decided to bid for a contract to supply shovels to the Honduran Army. The Honduran Army intends to buy 1,000 shovels per year for the next three years. To supply these shovels, Merton will have to acquire manufacturing equip
> You are the CFO of SlimBody, Inc., a retailer of the exercise machine Slimbody6 and related accessories. Your firm is considering opening up a new store in Los Angeles. The store will have a life of 20 years. It will generate annual sales of 5,000 exerci
> How do we adjust for depreciation when we calculate incremental after-tax free cash flow from EBITDA? What is the intuition for the adjustment?
> You are thinking about delivering pizzas in your spare time. Since you must use your own car to deliver the pizzas, you will wear out your current car one year earlier, which is one year from today, than if you did not take on the delivery job. You estim
> Anaconda Manufacturing Company currently own a mine that is known to contain a certain amount of gold. Since Anaconda does not have any gold-mining expertise, the company plans to sell the entire mine and base the selling price on a fixed multiple of the
> Assume that you are considering replacing your old Nissan with a new Hyundai, as in the previous problem. However, the annual maintenance cost of the old Nissan increases as time goes by. It is $1,200 in the first year, $1,500 in the second year, and $1,
> You have a 2000 Nissan that is expected to run for another three years, but you are considering buying a new Hyundai before the Nissan wears out. You will donate the Nissan to Goodwill when you buy the new car. The annual maintenance cost is $1,500 per y
> Bell Mountain Vineyards is considering updating its current manual accounting system with a high-end electronic system. While the new accounting system would save the company money, the cost of the system continues to decline. The Bell Mountainâ
> Predator LLC, a leveraged-buyout specialist, recently bought a company and wants to determine the optimal time to sell it. The partner in charge of this investment has estimated the after-tax cash flows from a sale at different times to be as follows: $7
> When can we not simply compare the NPVs of two mutually exclusive projects?
> You are starting a family pizza parlor and need to buy a motorcycle for delivery orders. You have two models in mind. Model A costs $9,000 and is expected to run for 6 years; Model B is more expensive, with a price of $14,000, and has an expected life of
> You are trying to choose between purchasing one of two machines for a factory. Machine A costs $15,000 to purchase and has a three-year life. Machine B costs $17,700 to purchase but has a four year life. Regardless of which machine you purchase, it will
> Archer Daniels Midland Company is considering buying a new farm that it plans to operate for 10 years. The farm will require an initial investment of $12 million. This investment will consist of $2 million for land and $10 million for trucks and other eq
> Given the soaring price of gasoline, Ford is considering introducing a new production line of gas-electric hybrid sedans. The expected annual unit sales of the hybrid cars is 30,000; the price is $22,000 per car. Variable costs of production are $10,000
> Healthy Potions, Inc., is considering investing in a new production line for eye drops. Other than investing in the equipment, the company needs to increase its cash and cash equivalents by $10,000, increase the level of inventory by $30,000, increase ac
> You are buying a sofa. You will pay $200 today and make three consecutive annual payments of $300 in the future. The real rate of return is 10 percent, and the expected inflation rate is 4 percent. What is the actual price of the sofa?
> Explain the concept of equivalent annual cost and how it is used to compare projects with different lives?
> Define expected cash flows, and explain why this concept is important in evaluating projects?
> Keswick Supply Company wants to set up a division that provides copy and fax services to businesses. Customers will be given 20 days to pay for such services. The annual revenue of the division is estimated to be $25,000. Assuming that the customers take
> Why do we use forecasted incremental after-tax free cash flows instead of forecasted accounting earnings in estimating the NPV of a project?
> How are working capital items forecast? Why are accounts receivable typically forecast as a percentage of revenue and accounts payable and inventories as percentages of the cost of good sold?
> Blanda Incorporated management is considering investing in two alternative production systems. The systems are mutually exclusive, and the cost of the new equipment and the resulting cash flows are shown in the accompanying table. If the firm uses a 9 p
> Management of Franklin Mints, a confectioner, is considering purchasing a new jelly bean-making machine at a cost of $312,500. They project that the cash flows from this investment will be $121,450 for the next seven years. If the appropriate discount ra
> Compute the IRR for each of the following projects: Year Project 1 Project 2 Project 3 $(10,000) $(10,000) S(10,000) 4,750 1,650 800 3,300 3,890 1,200 3,600 5,100 2,875 2,100 2,750 3,400 5 80 6,600 2. 3. 4.
> Management of Larsen Automotive, a manufacturer of auto parts, is considering investing in two projects. The company typically compares project returns to a cost of funds of 17 percent. Compute the IRRs based on the cash flows in the following table. Whi
> Jekyll & Hyde Corp. management is evaluating two mutually exclusive projects. The cost of capital is 15 percent. Costs and cash flows for each project are given in the following table. Which project should be accepted? Year Project 1 Project 2 S(
> Management of Intrepid, Inc., is considering investing in three independent projects. The costs and the cash flows are given in the following table. The appropriate cost of capital is 14.5 percent. Compute the project IRRs and identify the projects that
> Management of Draconian Measures, Inc., is evaluating two independent projects. The company uses a 13.8 percent discount rate for such projects. The costs and cash flows for the projects are shown in the following table. What are their NPVs? Year Pro
> Suppose that you could invest in the same projects as in the previous problem, but have only $25,000 to invest. Which projects would you chose?
> Crescent Industries management is planning to replace some existing machinery in its plant. The cost of the new equipment and the resulting cash flows are shown in the accompanying table. If the firm uses an 18 percent discount rate for projects like thi
> Suppose that you could invest in the following projects but have only $30,000 to invest. How would you make your decision and in which projects would you invest? Project Cost NPV A $ 8,000 $4,000 B 11,000 7,000 9,000 5,000 D 7,000 4,000
> What is the difference between variable and fixed costs, and what are examples of each?
> Compute the IRR for the following project cash flows: a. An initial outlay of $3,125,000 followed by annual cash flows of $565,325 for the next eight years. b. An initial investment of $33,750 followed by annual cash flows of $9,430 for the next five yea
> Compute the IRR on the following cash flow streams: a. An initial investment of $25,000 followed by a single cash flow of $37,450 in year 6. b. An initial investment of $1 million followed by a single cash flow of $1,650,000 in year 4. c. An initial inve
> Ancala Corporation management is considering investments in two new golf apparel lines for next season: golf hats and belts. Due to a funding constraint, these lines are mutually exclusive. A summary of each project’s estimated cash flo
> Refer to problem 10.5. Compute the IRR for both production System 1 and production System 2. Which has the higher IRR? Which production system has the higher NVP? Explain why the IRR and NPV rankings of Systems 1 and 2 are different? Refer to proble
> Management of Great Flights, Inc., an aviation firm, is considering purchasing three aircraft for a total cost of $161 million. The company would lease the aircraft to an airline. Cash flows from the proposed leases are shown in the following table. What
> Management of Sycamore Home Furnishings is considering acquiring a new machine that can create customized window treatments. The equipment will cost $263,400 and will generate cash flows of $85,000 over each of the next six years. If the cost of capital
> Morningside Bakeries recently purchased equipment at a cost of $650,000. Management expects the equipment to generate cash flows of $275,000 in each of the next four years. The cost of capital is 14 percent. What is the MIRR for this project?
> Hathaway, Inc., a resort management company, is refurbishing one of its hotels at a cost of $7.8 million. Management expects that this will lead to additional cash flows of $1.8 million for the next six years. What is the IRR of this project? If the appr
> An investment of $150,000 is expected to generate an after-tax cash flow of $100,000 in one year and another $120,000 in two years. The cost of capital is 10 percent. What is the internal rate of return? a. 28.19 percent b. 28.39 percent c. 28.59 percent
> An investment of $100 generates after-tax cash flows of $40 in Year 1, $80 in Year 2, and $120 in Year 3. The required rate of return is 20 percent. The net present value is closest to a. $42.22 b. $58.33 c. $68.52 d. $98.95
> How can FCF in the terminal year of a project’s life differ from FCF in the other years?
> Given the following cash flows for a capital project, calculate its payback period and discounted payback period. The required rate of return is 8 percent. The discounted payback period is a. 0.16 year longer than the payback period. b. 0.80 year longer
> Given the following cash flows for a capital project, calculate the NPV and IRR. The required rate of return is 8 percent. …. NPV …………â€&brvba
