Fin M12 Project Evaluation—Cash Flows and Capital Budgeting Techniques

Module 12 Critical Thinking Assignment

Project Evaluation- Cash Flows and Capital Budgeting Techniques

*Complete the problems in an Excel spreadsheet. Be sure to show your work to receive credit, no hard keys.

Problem 12-1: NPV and IRR

You are considering a project with an initial cash outlay of $80,000 and expected free cash flows of $20,000 at the end of each year for 6 years. The required rate of return for this project is 10 percent.

What is the project’s NPV?

What is the project’s IRR?

Problem 12-2: IRR

Your investment advisor has offered you an investment that will provide you with one cash flow of 10,000 SAR at the end of 20 years if you pay premiums of 200 SAR per year at the end of each year for 20 years. Find the internal rate of return on this investment.

Problem 12-3: Relevant Cash Flows

SSST Restaurant is considering expanding with three new locations. These expansion projects will be financed through a line of credit with FUT Bank. Part of this new line of credit includes administrative costs of 200 SAR per month, and the interest payments are expected to be 2,000 SAR per month. The new restaurants will occupy existing buildings, with rent of 2,500 SAR per month. What are the incremental cash flows for the new restaurants?

Problem 12-4: Calculating Free Cash Flows

RSC, Inc. is introducing a new product and has an expected change in EBIT of 475,000 SAR. RSC, Inc. has a 21% marginal tax rate. Bonus depreciation will be 250,000 SAR in year 1. In addition, the project will cause the following changes in year 1:

	Without
	Project	With Project
Accounts Receivable	SAR 45,000	SAR 63,000
Inventory	65,000	80,000
Accounts Payable	70,000	94,000

What is the project’s free cash flows for Year 1?

Problem 12-5: New Project Analysis

GT, Inc. is considering the purchase of a new production machine for 200,000 SAR. The purchase of this machine will result in an increase in earnings before interest and taxes of 50,000 SAR per year. To operate the machine properly, workers would have to go through a brief training session that would cost 5,000 SAR after taxes. It would cost 5,000 SAR to install the machine properly. Also, because this machine is extremely efficient, its purchase would necessitate an increase in inventory of 20,000 SAR. This machine has an expected life of 10 years, after which it will have no salvage value. Finally, to purchase the new machine, it appears that the firm would have to borrow 100,000 SAR at 8 percent interest from its local bank, resulting in additional interest payments of 8,000 SAR per year. Assume that the firm uses the bonus depreciation method and that GT, Inc. is very profitable, and if there are any losses from this project in year 1, GT, Inc. will be able to receive the tax benefits from those losses in year 1, a 21 percent marginal tax rate, and a required rate of return of 10 percent.

a. What is the initial outlay associated with this project? b. What are the annual after-tax cash flows associated with this project for years 1, and 2 through 9?

c. What is the terminal cash flow in year 10 (what is the annual after-tax cash flow in year 10 plus any additional cash flows associated with the termination of the project)?

d. Should the machine be purchased?