Managerial Finance

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Chapter I 1 Cash Flow llstimation and Risk Analysis

year 3. The earth mover would have no effect on revenuesr but it is expected to save the

firm $20,000 per year in before-tix operating costs, mainly labor. The finn's marginal

federal-plus-state tax rate is 407o-

a. What are the Year-0 cash flows? b. What are the operating cash flows in Years 1,2' and 3? c. What are the additional (nonoperating) cash flows in Year 3?

d. If the project's cost of capital is 10%, should the earth mover be purchased?

The staff of Porter Manufacturing has estimated the follorving net after-tax cash tlows and

probabilities for a new manufacturing Process:

Net After-Tax Cash Flows

Year P = 0.2 P=0.6 P=0.2

{sr-2) Corporate Risk

Analysis

0 -$100,000 I 20,000 2 20,000 3 20,000 4 20,000 5 20,000 5*0

-$100,000 -$ 100,000 30,000 40,000 30,000 40,000 30,000 40,000 30,000 40,000 30,000 40,000 20,000 30,000

Line 0 gives the cost of the process, Lines 1 through 5 give operating cash flows, and

Line 5* contains the estimated salvage values. Porter's cost of capital for an average-risk

project is 107o.

a. Assume that the project has average risk. Find the project's expected NPV. (Hinf: Use

expected values for the net cash flow in each year.) b. Find the best-case and worst-case NPVs. What is the probability of occurrence of the

.\.t/orst case if the cash flows are perfectly dependent (perfectly positively correlated) over time? If they are independent over time?

c. Assume that all the cash flows are perfectly positively correlated. That is, assume

there are only three possible cash flow streams over time-the worst case, the most

likely (or base) case, and the best case-with respective probabilities of 0'2, 0.6, and

0.2. These cases are represented by each of the columns in the table. Find the

expected NPV, its standard deyiation, and its coefficient of variation.

Easy Problems 1-4

(11'4 Investment OutlaY

Talbot Industries is considering launching a new product. The new manufacturing

equipment will cost $17 million, and production and sales will require an initial $5 million

investment in net operating working capital. The company's tax rate is 40Yo.

a. What is the initial investrnent outlay? b. The company spent and expensed $150,000 on research related to the new product

last year. Would this change your answer? Explain.

c. Rather than build a new manufacturing facility, the company plans to install the

equipment in a building it owns but is not now using. The building could be sold for

$i.S miilion after taxes and real estate commissions. How would this affect your

answer?