1.

Determining net cash flows A machine in use by a partnership was purchased 2 years
ago for $40,000. The machine is being depreciated under MACRS, using a 5-year
recovery period. It has 3 years of life remaining, and it can be sold today to net $42,000.
A new machine, using a 3-year MACRS recovery period, can be purchased at a price of
$140,000. It requires $10,000 to install and has a 3-year usable life. If the new machine is
acquired, the investment in accounts receivable will be expected to rise by $10,000, the
inventory investment will increase by $25,000, and accounts payable will increase by
$15,000. Earnings before interest, taxes, depreciation, and amortization are expected to
be $70,000 for each of the next 3 years with the old machine and to be $120,000 in the
first year and $130,000 in the second and third years with the new machine. At the end of
3 years, the market value of the old machine will equal zero, but the new machine could
be sold to net $35,000 before taxes. The firm is subject to a 40% tax rate and a 8 percent
required return. (Table 4.2 contains the applicable MACRS depreciation percentages.)
a. Determine the initial investment associated with the proposed replacement decision.
b. Calculate the operating cash flows for years 1 to 4 associated with the proposed
replacement. (Note: Only depreciation cash flows must be considered in year 4.)
c. Calculate the terminal cash flow associated with the proposed replacement decision.
(Note: This decision is made at the end of year 3.)
d. Depict on a timeline the net cash flows found in parts a, b, and c that are associated
with the proposed replacement decision, assuming it is terminated at the end of year
3.
Answer:
MARCS Depreciation (Old Machine)
Yea Depre Cost Percentage Depreciation Book Value
r
1 $ 40.000 20% $ 8.000 $ 32.000
2 $ 40.000 32% $ 12.800 $ 19.200
3 $ 40.000 19% $ 7.600 $ 11.600
4 $ 40.000 12% $ 4.800 $ 6.800
5 $ 40.000 12% $ 4.800 $ 2.000
6 $ 40.000 5% $ 2.000 $ -

MARCS Depreciation (New Machine)

Yea Depre Cost Percentage Depreciation Book Value
r
1 $ 150.000 33% $ 49.500 $ 100.500
2 $ 150.000 45% $ 67.500 $ 33.000
3 $ 150.000 15% $ 22.500 $ 10.500
4 $ 150.000 7% $ 10.500 $ -
 a. Determine the initial investment associated with the proposed replacement decision.
Initial Investment
Installed cost of the new assets
Cost of the new assets $
140.000
+ Installation Costs $
10.000
Total Installed cost $
150.000
(-) After-tax proceeds from the sale of the old asset
Proceeds from sale of the old assets $
42.000
- Tax on the sale of the old assets $
9.120
Total after tax proceeds $
32.880
(+) Change in net working capital $
20.000
Initial Investment $
137.120
*Tax on sale old assets calculation:
= (Selling price – Book Value) x 40%
= ($42,000 - $19,200) x 40%
= $22,800 x 40%
= $9,120
*Change in net working capital = Current Assets – Current Liabilities
b. Calculate the operating cash flows for years 1 to 4 associated with the proposed
replacement. (Note: Only depreciation cash flows must be considered in year 4.)
Operating Cash Flow New Machine
  Year 1 Year 2 Year 3 Year 4
EBITDA $ 120.000 $ 130.000 $ 130.000 $ -
Less:        
Depreciation $ 49.500 $ 67.500 $ 22.500 $ 10.500
EBIT $ 70.500 $ 62.500 $ 107.500 $ (10.500)
Tax (40%) $ 28.200 $ 25.000 $ 43.000 $ (4.200)
Earnings $ 42.300 $ 37.500 $ 64.500 $ (6.300)
Add:     Flow Old Machine
Operating Cash    
  Depreciation $ Year49.500
1 $ Year67.500
2 $Year 22.500
3 $Year
10.500
4
OCF
EBITDA $$ 91.800
70.000 $ $ 105.000
70.000 $ $ 70.000
87.000 $ $ -4.200
Less:        
Depreciation $ 7.600 $ 4.800 $ 4.800 $ 2.000
EBIT Net Operating
$ Cash
62.400 Flow $ 65.200 $ 65.200 $ (2.000)
Tax (40%) $ 24.960 $ 26.080 $ 26.080 $ (800)
Earnings $ 37.440 $ 39.120 $ 39.120 $ (1.200)
Add:        
Depreciation $ 7.600 $ 4.800 $ 4.800 $ 2.000
OCF $ 45.040 $ 43.920 $ 43.920 $ 800
 Yea Old
New Machine Net OCF
r Machine
1 $ 91.800 $ 45.040 $ 46.760
2 $ 105.000 $ 43.920 $ 61.080
3 $ 87.000 $ 43.920 $ 43.080
4 $ 4.200 $ 800 $ 3.400
  Total Net OCF $ 154.320

c. Calculate the terminal cash flow associated with the proposed replacement decision.
(Note: This decision is made at the end of year 3.)
Terminal cash flow
After-tax proceeds from the sale of the new machine
Proceeds from the sale of new machine $ 35.000
- Tax on sale of new machine $ 9.800
Total after-tax proceeds new machine $ 25.200
(-) After-tax proceeds from the sale of the old
machine
Proceeds from the sale of old machine $ 0
- Tax on sale of old machine $ -800
Total after-tax proceeds old machine $ 800
(+) Change in net working capital $ 20.000
Terminal cash flow $ 44.400
*Tax on sale new machine *Tax on sale old machine
= (Selling price – Book Value) x 40% = (Selling price – Book Value) x 40%
= ($35,000 - $10,500) x 40% = ($0 - $2.000) x 40%
= $24,500 x 40% = -$2.000 x 40%
= $9,800 = -800
d. Depict on a timeline the net cash flows found in parts a, b, and c that are associated
with the proposed replacement decision, assuming it is terminated at the end of year
3.

Tambahan:
Project
 Initial Investment $ -137.120 $ -137.120
Year (t) (1) (2) Present Value (1) : (2)
1 $ 46.760 1,08^1 $ 42.899
2 $ 61.080 1,08^2 $ 51.410
3 $ 87.480 1,08^3 $ 67.551
Net Present Value $ 24.740

Internal Rate Return

17,8%

=irr()
=npv(F6;)+

2. Fitch Industries is in the process of choosing the better of two equal-risk, mutually
exclusive capital expenditure projects, M and N. The relevant cash flows for each project
are shown in the following table. The firm’s cost of capital is 9%.
 a. Calculate each project’s payback period.
b. Calculate the net present value (NPV) for each project.
c. Calculate the internal rate of return (IRR) for each project.
d. Summarize the preferences dictated by each measure you calculated, and indicate
which project you would recommend. Explain why.
e. Draw the net present value profiles for these projects on the same set of axes, and
explain the circumstances under which a conflict in rankings might exist.
Answer:
a. Project M = 2,85 year
Project N = 2,5 year

Calculate Project M payback period:

Year 1 = $14.000
Year 2 = $14.000 +
= $28.000
Year 3 = $12.000 +
= $40.000
Payback period = 2 year + (12.000/14.000)
= 2 year + 0.85 year
= 2.85 year
Calculate Project N payback period:
Year 1 = $23.000
Year 2 = $12.000 +
= $35.000
Year 3 = $ 5.000 +
= $40.000
Payback period = 2 year + (5.000/10.000)
= 2 year + 0.5 year
= 2.5 year
Project M
Initial Investment $ -40.000 $ -40.000
Year (t) (1) (2) Present Value (1) : (2)
b. 1 $ 14.000 1,09^1 $ 12.844
2 $ 14.000 1,09^2 $ 11.784
3 $ 14.000 1,09^3 $ 10.811
4 $ 14.000 1,09^4 $ 9.918

Net Present Value (NPV) $ 5.356

 Project N
Initial Investment $ -40.000 $ -40.000
Year (t) (1) (2) Present Value (1) : (2)
1 $ 23.000 1,09^1 $ 21.101
2 $ 12.000 1,09^2 $ 10.100
3 $ 10.000 1,09^3 $ 7.722
4 $ 9.000 1,09^4 $ 6.376

Net Present Value (NPV) $ 5.299

c. Internal Rate Return (IRR)

Project M = 14,96%
Project N = 16,19%

d. Summarize the preferences dictated by each measure you calculated, and indicate which
project you would recommend. Explain why.

Project
Project M Project N
Payback Period 2.85 year 2.5 year
NPV $ 5.356 $ 5.299
IRR 14.96% 16.19%

Project M has a higher NPV, but project N has a faster payback and a higher IRR. Thus,
the techniques do not agree on which project is best. However, in general when these
measures conflict, it is best to go with the higher NPV, which in this case is Project M.

e.
 NPV Profile
$20,000

$15,000

$10,000

$5,000

$-
0% 2% 4% 6% 8% 9% 13% 15% 16% 18% 20% 22%

$(5,000)

$(10,000)

Project M Project N

Net Present Value

Project M Project N From the NPV profile, you can see that Project M has a
0% $ $ 14.000 higher NPV when the discount rate is below 10%, but
16.000 project N has a higher NPV at discount rates of 10% and
2% $ $ 11.589 above. More precise calculations would show that the
13.047 two NPV profiles cross (i.e., the two projects have the
4% $ $ 9.417 same NPV) when the dis-count rate is about 9.34%.
10.402 Project N’s NPV is less sensitive to the discount rate
6% $ $ 7.456
(i.e., its NPV falls more slowly when the discount rate
8.030
rises compared to the NPV of Project M) because it
8% $ $ 5.683
5.898 provides a great deal of cash in year 1, whereas Project
9,34% $ $ 4.591 M’s cash flow is spread out evenly over time.
4.591
13% $ $ 1.949
1.454
14,96% $ $ 713
(0)
16,19% $ $ 0
(835)
18% $ (1.982) $ (985)
20% $ (3.131) $ (1.977) 3. Newlin Electronics is considering additional
22% $ (4.171) $ (2.882) financing of $10,000. It currently has $50,000 of
12% (annual interest) bonds and 10,000 shares of
common stock outstanding. The firm can obtain the financing through a 12% (annual
interest) bond issue or through the sale of 1,000 shares of common stock. The firm has a
21% tax rate.
Answer:
= $50,000 x 12% : $6.000
= $10,000 x 12% : $1.200
: $7.200
( 1−T ) x ( EBIT −I )−PD
EPS =
n
( 1−0.21 ) x ( EBIT −$ 7.200 ) ( 1−0.21 ) x ( EBIT −$ 6.000 )
=
10.000 11.000
( 0.79 ) x ( EBIT −$ 7.200) ( 0.79 ) x (EBIT −$ 6.000)
=
10.000 11.000
0.79 EBIT - $5.688 = 0.79 EBIT - $4.740
10.000 11.000
8.690 EBIT - $62.568.000 = 7.900 EBIT - $47.400.000
790 EBIT = $15.168.000
EBIT = $19.200

Bonds (1) Shares (1) Bonds (2) Shares (2) Bonds (3) Shares (3)
EBIT $19.200 $19.200 $25.000 $25.000 $13.000 $13.000
Interest $7.200 $6.000 $7.200 $6.000 $7.200 $6.000
EBT $12.000 $13.200 $17.800 $19.000 $5.800 $7.000
Taxes $2.520 $2.772 $3.738 $3.990 $1.218 $1.470
EAT $9.480 $10.428 $14.062 $15.010 $4.582 $5.530
OTS 10.000 11.000 10.000 11.000 10.000 11.000
EPS 0.948 0.948 1.40 1.36 0.45 0.50

EBIT = Earnings Before Interest Tax

EBT = Earnings Before Tax
EAT = Earnings After Tax
OTS = Outstanding Shares
EPS = Earnings per Shares
 4. TOR most recently sold 100,000 units at $7.50 each; its variable operating costs are
$3.00 per unit, and its fixed operating costs are $250,000. Annual interest charges total
$80,000, and the firm has 8,000 shares of $5 (annual dividend) preferred stock
outstanding. It currently has 20,000 shares of common stock outstanding. Assume that
the firm is subject to a 40% tax rate.
a. At what level of sales (in units) would the firm break even on operations (i.e., EBIT =
$0)?
b. b. Calculate the firm’s earnings per share (EPS) in tabular form at (1) the current level
of sales and (2) a 120,000-unit sales level.
c. c. Using the current $750,000 level of sales as a base, calculate the firm’s degree of
operating leverage (DOL).
d. d. Using the EBIT associated with the $750,000 level of sales as a base, calculate the
firm’s degree of financial leverage (DFL).
e. e. Use the degree of total leverage (DTL) concept to determine the effect (in per-
centage terms) of a 50% increase in TOR’s sales from the $750,000 base level on its
earnings per share.
Answer:
a.
BEP = (SP-VC)Q - FC
0= ($7.50 - $3.00) Q - $250,000
0= $4.5Q - $250,000
$4.5 Q : $250.000
Q= 55.556 units
Sales (in units) 100.000 Units 20% 120.000Units
Sales Revenue $ 750.000 $ 900.000
Less: Variable Costs $ 300.000 $ 360.000
Less: Fixed Costs $ 250.000 $ 250.000
Earnings Before Interest and Taxes (EBIT) $ 200.000 45% $ 290.000
Less: Interest $ 80.000 $ 80.000
Net profits before taxes $ 120.000 $ 210.000
Less: Taxes $ 48.000 $ 84.000
Net profits after taxes $ 72.000 $ 126.000
Less: Preferred stock dividends (PD) $ 40.000 $ 40.000
Earnings available for common $ 32.000 $ 86.000
(20.000 outstanding shares)
Earnings per shares (EPS) $ 1,60 168,75% $ 4,30
b.
% Change in EBIT = $290.000 - $200.000 / $200.000
= 45%
% Change in Sales = 120.000 units – 100.000 units/ 100.000 units
= 20%
% Change in EPS = $4.3 - $1.6/ $1.6
= 168,75%
c.
DOL = % Change in EBIT
% Change in Sales
45%
20%
= 2,25
d.
DFL = % Change in EPS
% Change in EBIT
168,75%
45%
= 3,75
e.
DTL = % Change in EPS

% Change in Sales
168,75%
20%
= 8,44
 5. Thompson Paint Company uses 60,000 gallons of pigment per year. The cost of ordering
pigment is $200 per order, and the cost of carrying the pigment in inventory is $1 per
gallon per year. The firm uses pigment at a constant rate every day throughout the year.
Calculate the EOQ.
Assuming that it takes 20 days to receive an order once it has been placed, determine the
reorder point in terms of gallons of pigment. (Note: Use a 365-day year.)
Explanation:
a) Economic Order Quantity (EOQ)
 OCost of Ordering Pigment = $ 200
 DAnnual Demand (gallons) = 60,000 gallons
 CAnnual Carrying Cost per Gallon= $1
So:

2∗O∗D
EOQ=
√ C

2∗$ 200∗60,000
EOQ=
√ $1

$ 24,000,000
EOQ=
√ $1
EOQ=4,898.98 gallons
b) Reorder Point in Gallons
The Daily Usage Rate is given by:
Annual Demand
¿
Number of Days∈a Year
60,000 gallons
¿
365 days
¿ 164.38 gallons per day
So:
The Reorder Point in Gallons is given by:
¿ Average Daily Usage Rate∗Lead Time Between
¿ 164.38 gallons∗20
¿ 3,287.67 gallons
6. Regency Rug Repair Company is trying to decide whether it should relax its credit
standards. The firm repairs 72,000 rugs per year at an average price of $32 each. Bad-
 debt expenses are 1% of sales, the average collection period is 40 days, and the variable
cost per unit is $28. Regency expects that if it does relax its credit standards, the average
collection period will increase to 48 days and that bad debts will increase to 11 /2% of
sales. Sales will increase by 4,000 repairs per year. If the firm has a required rate of
return on equal-risk investments of 14%, what recommendation would you give the firm?
Use your analysis to justify your answer. (Note: Use a 365-day year.)
Explanation:
Additional Profit Contribution from Sales:
¿ Rugincrease∗( Average Sales Price−Variable Cost per Unit )
¿ 4,000 rugs∗ ( $ 32−$ 28 )
¿ 4,000∗$ 4
¿ $ 16,000
Cost of Marginal Investment in Account Receivable
Average Investement Under Proposed Plan:
Variable Cost per Unit∗Total Rugs Repair
¿
Days∈a Year
Average Collection Period (Increased)
¿¿
$ 28∗$ 76,000
365
48
$ 2,128,000
7.6
¿ $ 280,000
Average Investment Under Present Plan:
Variable Cost per Unit∗Rugs Repair
¿
Days∈a Year
Average Collection Period
$ 28∗( $ 72,000)
¿=
365
40
$ 2,016,000
¿
$ 9.125
¿ $ 220,932
Marginal Investment in A/R:
¿ Average Investment Under Proposed Plan− Average Investment Under Present Plan
¿ $ 280,000−$ 220,932
¿ $ 59,068
Cost of Marginal Investment in A/R:
¿ Rate of Returnon Equal Risk Investment∗Marginal Investment ∈ AR
¿ 14 %∗$ 59,068
¿ $ 8,269,70
¿ $ 8,270
Cost of Marginal Bad Debts
Bad Debts Under Proposed Plan:
¿ Rate of Bad Debt Increased∗Average Price∗Total Rug Repairs ¿
¿ 0.015∗$ 32∗( 72,000+4,000 )
¿ 0.015∗$ 32∗76,000
¿ $ 36,480
Bad Debts Under Present Plan:
¿ Rate of Bad Debt Expense∗Average Price∗Rugs Repair
¿ 0.010∗$ 32∗72,000
¿ $ 23,040
Cost of Marginal Bad Debts:
¿ Bad Debts Under Proposed Plan−Bad Debts Under Present Plan
¿ $ 36,480−$ 23,040
¿ $ 13,440
Net Loss from Implementation of Proposed Plan:
¿ Additional Profit Contribution ¿ Sales−Cost of Marginal Investment ∈ AR−Cost of Marginal Bad Debts
¿ $ 16,000−$ 8,270−$ 13,440
¿−$ 5,710
¿ ( $ 5,710 )

Or in other ways:
Additional Profit Contribution from Sales:
(4,000 units*($32-$28) $ 16,000
Average Investement Under Proposed Plan:
$ 28∗76,000 $ 2,128,000 $ 280,000
=
7.6 7.6
Average Investment Under Present Plan:
$ 28∗72,000 $ 2,016,000 $220,932 -
=
9.125 9.125
Marginal Investment in A/R $59,068
Cost of Marginal Investment in A/R (0.14*59,068) $ 8,270
Cost of Marginal Debts:
Bad Debts Under Proposed Plan (0.015*$32*76,000) $36,480
Bad Debts Under Present Plan (0.01*$32*$72,000) $23,040 -
Cost of Marginal Debts: $13,440 -
Net Profit from Implemetation of Proposed Plan ($5,710)

Conclusion:
From the calculation above we can conclude that the proposed plan result is make net loss
of $5,710. So, we can choose the decisions that the proposed plan should not be
implemented in this situation for the company.