Making Capital Investment Decisions
CHAPTER 9
MAKING CAPITAL INVESTMENT DECISIONS
Solutions to Questions and Problems
1. The $7 million acquisition cost of the land six years ago is a sunk cost. The $9.8 million current aftertax value of the land is an opportunity cost if the land is used rather than sold off. The $21 million cash outlay and $850,000 grading expenses are the initial fixed asset investments needed to get the project going. Therefore, the proper year zero cash flow to use in evaluating this project is
Cash outflow = $9,800,000 + 21,000,000 + 850,000 Cash outflow = $31,650,000
2. Sales due solely to the new product line are:
23,000($19,000) = $437,000,000
Increased sales of the motor home line occur because of the new product line introduction; thus:
2,600($73,000) = $189,800,000
if new sales is relevant. Erosion of luxury motor coach sales is also due to the new mid-size campers; thus:
850($115,000) = $97,750,000 loss in sales
is relevant. The net sales figure to use in evaluating the new line is thus:
Net sales = $437,000,000 + 189,800,000 – 97,750,000 Net sales = $529,050,000
4. To find the OCF, we need to complete the income statement as follows:
Sales $ 643,800 Variable costs 345,300 Depreciation 96,000 EBIT $ 202,500 Taxes@35% 70,875 Net income $ 131,625
The OCF for the company is:
OCF = EBIT + Depreciation – Taxes OCF = $202,500 + 96,000 – 70,875 OCF = $227,625
The depreciation tax shield is the depreciation times the tax rate, so:
Depreciation tax shield = TcDepreciation Depreciation tax shield = .35($96,000) Depreciation tax shield = $33,600
The depreciation tax shield shows us the increase in OCF by being able to expense depreciation.
6. The asset has an 8-year useful life and we want to find the BV of the asset after 5 years. With straight-line depreciation, the depreciation each year will be:
MAKING CAPITAL INVESTMENT DECISIONS
Solutions to Questions and Problems
1. The $7 million acquisition cost of the land six years ago is a sunk cost. The $9.8 million current aftertax value of the land is an opportunity cost if the land is used rather than sold off. The $21 million cash outlay and $850,000 grading expenses are the initial fixed asset investments needed to get the project going. Therefore, the proper year zero cash flow to use in evaluating this project is
Cash outflow = $9,800,000 + 21,000,000 + 850,000 Cash outflow = $31,650,000
2. Sales due solely to the new product line are:
23,000($19,000) = $437,000,000
Increased sales of the motor home line occur because of the new product line introduction; thus:
2,600($73,000) = $189,800,000
if new sales is relevant. Erosion of luxury motor coach sales is also due to the new mid-size campers; thus:
850($115,000) = $97,750,000 loss in sales
is relevant. The net sales figure to use in evaluating the new line is thus:
Net sales = $437,000,000 + 189,800,000 – 97,750,000 Net sales = $529,050,000
4. To find the OCF, we need to complete the income statement as follows:
Sales $ 643,800 Variable costs 345,300 Depreciation 96,000 EBIT $ 202,500 Taxes@35% 70,875 Net income $ 131,625
The OCF for the company is:
OCF = EBIT + Depreciation – Taxes OCF = $202,500 + 96,000 – 70,875 OCF = $227,625
The depreciation tax shield is the depreciation times the tax rate, so:
Depreciation tax shield = TcDepreciation Depreciation tax shield = .35($96,000) Depreciation tax shield = $33,600
The depreciation tax shield shows us the increase in OCF by being able to expense depreciation.
6. The asset has an 8-year useful life and we want to find the BV of the asset after 5 years. With straight-line depreciation, the depreciation each year will be: