ACF 103 – Fundamentals of Finance

Tutorial 7 - Solutions
Chapter 12
1. Project GROW will result in an increase of 5,000 units per year at a sale price
of $11 each (assume 0% inflation). The extra sales will generate additional
operating expenditures of $9 per unit plus $3,000 in fixed operating costs. In
addition, the firm will see an increase in depreciation expense of $12,000 per
year. The firm anticipates it will remain at the current marginal tax rate of
40% and that any project losses will offset other profits in the firm. What is
the interim incremental net cash flow?
A. -$10,000
* B. +$9,000
C. +$12,000
D. +$25,000

0.6[5,000(11 – 9) – 3000 – 12,000] + 12,000 = +9,000

2. The Holdun Real Estate Company wants to purchase new office equipment to
set up a branch office. The new equipment normally sells for $35,000 but can
be obtained for $30,000 if some old surplus machines that Holdun owns are
traded in. The old equipment has a book value of $1,000. The new machines
will cost $3,000 to install, and net working capital will increase by $500. If
Holdun's tax rate is 30%, what is the initial cash outflow?
Answer: Trade-in value = $5,000
Taxable value (above book) of "old" machine = $5,000 - $1,000 = $4,000
Initial cash outflow = $30,000 + $4,000(0.30) + $3,000 + $500 = $34,700

3. Flim Flam Films (FFF) has some usable equipment that it wants to replace. It
estimates that its additional annual benefits, expenses, and depreciation
charges (before taxes) will be as follows:

Incremental Incremental Incremental

Year Benefits Expenses Depreciation
1 $10,000 $4,000 $2,000
2 11,500 4,200 3,000
3 12,800 4,500 2,000
4 14,000 4,800 2,500

What are the annual incremental net cash flows if FFF's tax rate is 40%?

Answer:
Year 1: ($10,000 - $4,000)(0.60) + ($2,000)(0.40) = $4,400
Year 2: ($11,500 - $4,200)(0.60) + ($3,000)(0.40) = $5,580
Year 3: ($12,800 - $4,500)(0.60) + ($2,000)(0.40) = $5,780
Year 4: ($14,000 - $4,800)(0.60) + ($2,500)(0.40) = $6,520

4. Nickelsaver Press may buy new printing equipment costing $80,000. This
equipment is expected to reduce printing costs by $25,000 annually for the
next 5 years. The appropriate depreciation percentages on original cost are
0.3333, 0.4445, 0.1481, 0.0741, and 0 for years one through five, respectively.

ACF 103 HAUT 2015 Tutorial Solns

 No salvage value is expected at the end. If Nickelsaver's tax rate is 40%, what
are the relevant cash flows?

Answer:
Net cash flows in Year
1: ($25,000)(0.60) + ($80,000)(0.3333)(0.40) = $25,665.60
2: ($25,000)(0.60) + ($80,000)(0.4445)(0.40) = $29,224.00
3: ($25,000)(0.60) + ($80,000)(0.1481)(0.40) = $19,739.20
4: ($25,000)(0.60) + ($80,000)(0.0741)(0.40) = $17,371.20
5: ($25,000)(0.60) + 0 = $15,000.00

Homework problem
5. U.S. Glass in considering purchasing a more advanced glass extrusion
machine to replace the one currently being used in its production process. It is
projected that:

∙ The old machine can be used for four more years. It has a current salvage
value of $60,000. If held to the end of its useful life, the old machine would
have an estimated final salvage value of $40,000. This is the final year that tax
depreciation will be taken on the machine, and the amount of depreciation is
equal to the machine's remaining depreciated (tax) book value of $90,400.
∙ The new machine costs $1,200,000, plus an additional $40,000 for installation.
Its final salvage value is projected to be $300,000 at the end of its life. Annual
depreciation rates (on original depreciable value) are 0.3333, 0.4445, 0.1481
and 0.0741 respectively.
∙ It will require an increase in net working capital of $50,000 and will generate
a $50,000 decrease in net working capital at the end of its life.
∙ The new machine will reduce labour and maintenance costs by $240,000
annually.
∙ Income taxes on incremental profits are paid at a 40% rate.

Calculate the expected annual incremental cash flows for years one through
four, as well as the estimated initial cash outflow.
Answer:
Net cash flows in Year
0: -$1,200,000 - $40,000 - $50,000 + $60,000 + ($90,400 - $60,000)(0.40) = -1,217,840
1: ($240,000)(0.60) + ($1,240,000)(0.3333)(0.40) = 309,317
2: ($240,000)(0.60) + ($1,240,000)(0.4445)(0.40) = 364,472
3: ($240,000)(0.60) + ($1,240,000)(0.1481)(0.40) = 217,458
4: ($240,000)(0.60) + ($1,240,000)(0.0741)(0.40) = 180,754
($300,000)(0.60) + $50,000 = 230,000

Notes:
Salvage value is the amount the asset can be sold for
Depreciable value of the new asset is $1,240,000 (1,200,000 + 40,000)
Depreciation on old asset in its final year was $90,400 (the book value), but the asset
was worth just $60,000. Therefore there is a tax benefit (sale value is less than book
value) adjustment needed for the difference – $30,400 (i.e. 90,400 – 60,000)

ACF 103 HAUT 2015 Tutorial Solns

6. Text book Ch 12, problem # 3 (p.320)

Answer:
3. a. b.
Amount of cash outflow: Net cost savings of
Time of cash Rockbuilt over
outflow Rockbuilt Bulldog Bulldog truck
0 ($74,000) ($59,000) ($15,000)
1 (2,000) (3,000) 1,000
2 (2,000) (4,500) 2,500
3 (2,000) (6,000) 4,000
4 (2,000) (22,500) 20,500
5 (13,000) (9,000) (4,000)
6 (4,000) (10,500) 6,500
7 (4,000) (12,000) 8,000
8 5,000* (8,500)** 13,500
* $4,000 maintenance cost plus salvage value of $9,000.
** $13,500 maintenance cost plus salvage value of $5,000.

ACF 103 HAUT 2015 Tutorial Solns