Chapter 8 - Pearson Learning Solutions

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354 PART THREE Long-Term Investment Decisionspercentages) and is subject to a 40% tax rate. Estimate the incremental operatingcash inflows generated by the replacement. (Note: Be sure to consider the depreciationin year 6.)LG5P8–18 Incremental operating cash inflows Strong Tool Company has been consideringpurchasing a new lathe to replace a fully depreciated lathe that will last 5 moreyears. The new lathe is expected to have a 5-year life and depreciation charges of$2,000 in year 1; $3,200 in year 2; $1,900 in year 3; $1,200 in both year 4 andyear 5; and $500 in year 6. The firm estimates the revenues and expenses (excludingdepreciation and interest) for the new and the old lathes to be as shown in the followingtable. The firm is subject to a 40% tax rate.New latheOld latheExpensesExpensesYear Revenue (excl. depr. and int.) Revenue (excl. depr. and int.)1 $40,000 $30,000 $35,000 $25,0002 41,000 30,000 35,000 25,0003 42,000 30,000 35,000 25,0004 43,000 30,000 35,000 25,0005 44,000 30,000 35,000 25,000a. Calculate the operating cash inflows associated with each lathe. (Note: Be sure toconsider the depreciation in year 6.)b. Calculate the incremental (relevant) operating cash inflows resulting from theproposed lathe replacement.c. Depict on a time line the incremental operating cash inflows calculated in part b.LG6LG6P8–19 Terminal cash flow—Various lives and sale prices Looner Industries is currentlyanalyzing the purchase of a new machine that costs $160,000 and requires $20,000in installation costs. Purchase of this machine is expected to result in an increase innet working capital of $30,000 to support the expanded level of operations. Thefirm plans to depreciate the machine under MACRS using a 5-year recovery period(see Table 3.2 on page 98 for the applicable depreciation percentages) and expects tosell the machine to net $10,000 before taxes at the end of its usable life. The firm issubject to a 40% tax rate.a. Calculate the terminal cash flow for a usable life of (1) 3 years, (2) 5 years,and (3) 7 years.b. Discuss the effect of usable life on terminal cash flows using your findings inpart a.c. Assuming a 5-year usable life, calculate the terminal cash flow if the machinewere sold to net (1) $9,000 or (2) $170,000 (before taxes) at the end of 5 years.d. Discuss the effect of sale price on terminal cash flow using your findings in part c.P8–20 Terminal cash flow—Replacement decision Russell Industries is consideringreplacing a fully depreciated machine that has a remaining useful life of 10 yearswith a newer, more sophisticated machine. The new machine will cost $200,000and will require $30,000 in installation costs. It will be depreciated under MACRSusing a 5-year recovery period (see Table 3.2 on page 98 for the applicable deprecia-2008935971Principles of Managerial Finance, Brief Fifth Edition, by Lawrence J. Gitman. Copyright © 2009 by Lawrence J. Gitman. Published by Prentice Hall.
CHAPTER 8 Capital Budgeting Cash Flows 355tion percentages). A $25,000 increase in net working capital will be required to supportthe new machine. The firm’s managers plan to evaluate the potential replacementover a 4-year period. They estimate that the old machine could be sold at theend of 4 years to net $15,000 before taxes; the new machine at the end of4 years will be worth $75,000 before taxes. Calculate the terminal cash flow at theend of year 4 that is relevant to the proposed purchase of the new machine. The firmis subject to a 40% tax rate.LG4LG5LG6P8–21 Relevant cash flows for a marketing campaign Marcus Tube, a manufacturer ofhigh-quality aluminum tubing, has maintained stable sales and profits over the past10 years. Although the market for aluminum tubing has been expanding by 3% peryear, Marcus has been unsuccessful in sharing this growth. To increase its sales, thefirm is considering an aggressive marketing campaign that centers on regularly runningads in all relevant trade journals and exhibiting products at all major regionaland national trade shows. The campaign is expected to require an annual taxdeductibleexpenditure of $150,000 over the next 5 years. Sales revenue, as shownin the income statement for 2009 below, totaled $20,000,000. If the proposed marketingcampaign is not initiated, sales are expected to remain at this level in each ofthe next 5 years, 2010–2014. With the marketing campaign, sales are expected torise to the levels shown in the accompanying table for each of the next 5 years; costof goods sold is expected to remain at 80% of sales; general and administrativeexpense (exclusive of any marketing campaign outlays) is expected to remain at10% of sales; and annual depreciation expense is expected to remain at $500,000.Assuming a 40% tax rate, find the relevant cash flows over the next 5 years associatedwith the proposed marketing campaign.Marcus TubeIncome Statementfor the Year Ended December 31, 2009Sales revenue $20,000,000Less: Cost of goods sold (80%)Gross profits16,000,000$ 4,000,000Less: Operating expensesGeneral and administrative expense (10%) $2,000,000Depreciation expense500,000Total operating expenseEarnings before interest and taxes2,500,000$ 1,500,000Less: Taxes (rate40%)600,000Net operating profit after taxes $ 900,000YearMarcus TubeSales ForecastSales revenue2010 $20,500,0002011 21,000,0002012 21,500,0002013 22,500,0002014 23,500,0002008935971LG4LG5P8–22 Relevant cash flows—No terminal value Central Laundry and Cleaners is consideringreplacing an existing piece of machinery with a more sophisticated machine.The old machine was purchased 3 years ago at a cost of $50,000, and this amountwas being depreciated under MACRS using a 5-year recovery period. The machinehas 5 years of usable life remaining. The new machine that is being considered costs$76,000 and requires $4,000 in installation costs. The new machine would be depreciatedunder MACRS using a 5-year recovery period. The firm can currently sell thePrinciples of Managerial Finance, Brief Fifth Edition, by Lawrence J. Gitman. Copyright © 2009 by Lawrence J. Gitman. Published by Prentice Hall.
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Chapter 8 - Pearson Learning Solutions

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