Chapter 8 - Pearson Learning Solutions

CHAPTER 8 Capital Budgeting Cash Flows 347the firm’s investment in net working capital is expected to increase by $15,000. Thefirm pays taxes at a rate of 40%. (Table 3.2 on page 98 contains the applicableMACRS depreciation percentages.)a. Calculate the book value of the old piece of equipment.b. Determine the taxes, if any, attributable to the sale of the old equipment.c. Find the initial investment associated with the proposed equipment replacement.LG4LG5LG6ST8–2 Determining relevant cash flows A machine currently in use was originally purchased2 years ago for $40,000. The machine is being depreciated under MACRSusing a 5-year recovery period; it has 3 years of usable life remaining. The currentmachine can be sold today to net $42,000 after removal and cleanup costs. A newmachine, 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 newmachine is acquired, the investment in accounts receivable will be expected to riseby $10,000, the inventory investment will increase by $25,000, and accounts payablewill increase by $15,000. Earnings before depreciation, interest, and taxes areexpected 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 newmachine. 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 toa 40% tax rate. (Table 3.2 on page 98 contains the applicable MACRS depreciationpercentages.)a. Determine the initial investment associated with the proposed replacementdecision.b. Calculate the incremental operating cash inflows for years 1 to 4 associated withthe proposed replacement. (Note: Only depreciation cash flows must be consideredin year 4.)c. Calculate the terminal cash flow associated with the proposed replacement decision.(Note: This is at the end of year 3.)d. Depict on a time line the relevant cash flows found in parts a, b, and c that areassociated with the proposed replacement decision, assuming that it is terminatedat the end of year 3.Warm-Up Exercises A blue box (■) indicates exercises available in .2008935971LG1LG2E8–1 If Halley Industries reimburses employees who earn master’s degrees and whoagree to remain with the firm for an additional 3 years, should the expense ofthe tuition reimbursement be categorized as a capital expenditure or an operatingexpenditure?E8–2 Canvas Reproductions, Inc., is considering two mutually exclusive investments.Project A requires an initial outlay of $20,000 and has expected cash inflows of$5,000 for each of the next 5 years. Project B requires an initial outlay of $25,000and has expected cash inflows of $6,500 for each of the following 5 years. Usea simple rate of return measure to determine which project the company shouldchoose.Principles of Managerial Finance, Brief Fifth Edition, by Lawrence J. Gitman. Copyright © 2009 by Lawrence J. Gitman. Published by Prentice Hall.