St. John's Paper

1) The Seattle Corporation has been presented with an investment opportunity that will yield cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will cost the firm $150,000 today, and the firm’s cost of capital is 10 percent. What is the payback period for this investment?

Payback period

Using the even cash flow distribution assumption, the project will completely recover the initial investment after $30/$35 = 0.86 of Year 5:
Payback = 4 + = 4.86 years.

2) As the director of capital budgeting for Denver Corporation, you are evaluating two mutually exclusive projects with the following net cash flows:

Project
If the firm’s cost of capital is 14 percent and its tax rate is 40 percent, what is the project’s IRR?

IRR Financial calculator solution:
Inputs: CF0 = -200000; CF1 = 44503; Nj = 10. Output: IRR = 18%.

4) St. John’s Paper is considering purchasing equipment today that has a depreciable cost of $1 million. The equipment will be depreciated on a MACRS 5-year basis, which implies the following depreciation schedule:

MACRS Depreciation
Year Rates 1 0.20 2 0.32 3 0.19 4 0.12 5 0.11 6 0.06

Assume that the company sells the equipment after three years for $400,000 and the company’s tax rate is 40 percent. What would be the tax consequences resulting from the sale of the equipment?

Taxes on gain on sale When the machine is sold the total accumulated depreciation on it is: (0.20 + 0.32 + 0.19)  $1,000,000 = $710,000. The book value of the equipment is: $1,000,000 - $710,000 = $290,000. The machine is sold for $400,000, so the gain is $400,000 - $290,000 = $110,000. Taxes are calculated as $110,000  0.4 =
The company has estimated that the project’s NPV is $3 million, but this does not consider that the new laundry detergent will reduce the revenues received on its existing laundry detergent products. Specifically, the company estimates that if it develops WOW the company will lose $500,000 in after-tax cash flows during each of the next 10 years because of the cannibalization of its existing products. Ellison’s WACC is 10 percent. What is the net present value (NPV) of undertaking WOW after considering