Corporate Finance 1st Edition Booth Solutions Manual

Corporate Finance 1st Edition Booth
Solutions Manual
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Corporate Finance Instructor’s Manual
Chapter 11
Capital Budgeting: Cash Flows and Risk
Synopsis
The purpose of this chapter is to explain and demonstrate the estimation of cash flows associated
with a capital investment project. We describe a strategy of classifying cash flows into investment,
operating, and terminal cash flows, a strategy that can bring order to a messy set of cash flows.
We can use sensitivity analysis, scenario analysis, and simulation to help gauge the distribution of
possible outcomes to a project, which can then be used to evaluate the risk of a project. Special
issues, such as dealing with replacement decisions or grappling with inflation, are simple
extensions of the basic idea of determining the amount and timing of incremental cash flows of
project.
Learning Outcomes
LO 11.1 Identify the relevant cash flows for a capital budgeting analysis.
LO 11.2 Estimate the investment cash flows, operating cash flows, and terminal cash flows of an
investment project.
LO 11.3 Conduct a sensitivity analysis to examine the sensitivity of capital investment decisions to
the estimates of cash flows.
LO 11.4 Estimate cash flows for a replacement decision.
LO 11.5 Evaluate the effects of inflation on capital budgeting decisions.
Chapter Outline
11.1 Identifying relevant cash flows
What are the relevant cash flows?
11.2 Estimating cash flows

A. The investment cash flow
B. Operating cash flows
C. Terminal cash flows
D. Assembling the pieces
11.3 Sensitivity to inputs

A. Sensitivity analysis
B. Scenario analysis
C. Simulation analysis
Copyright © 2014 John Wiley & Sons, Inc. 11-1

11.4 Replacement decisions

An example
11.5 Inflation and capital budgeting

Nominal versus real cash flows
Integrative Problem: Dazzle

11A.1 The Project
11A.2 Analysis of the Facts
Dissecting the Problem
Assembling the Pieces
Scenario Analysis
Simulation Analysis
Discussion Questions for Special Features
Learning
Feature outcome Discussion questions
Opening vignette 11.3 1. What has happened to raising capital and capital investment
since 2008?
2. Why would capital investment be cyclical?
Global perspective: 11.2 1. How would tax credits affect the capital budgeting decision?
Using tax credits to 2. Why would countries compete for business to locate?
compete
Lesson learned: Tax 11.2 1. Why would one expect tax breaks to affect investment?
breaks don’t boost 2. If tax breaks do not stimulate investment spending, why
investment: Study would governments offer these breaks?
Finance in the news: 11.1 1. What is the paradox?
Gas drillers’ painful 2. Would this dilemma affect other industries as well?
growth paradox
Concept Review Questions

11.1 Identifying relevant cash flows
1. The cost of financing is reflected in the discount rate. Including the cost in the cash flows
would result in double counting this cost.
2. A sunk cost is something that would be spent whether or not the business went ahead
with the capital project, such as new product research and development. An
opportunity cost is something that is foregone if the business goes ahead with the
capital project. An example of an opportunity cost when a business decides to use a
building for a new project, when the business could have rented the building otherwise.

11.2 Estimating cash flows

1. The investment cash flow includes set-up and installation of the new asset, as well as
changes in the investment in other assets (such as inventory).
2. With respect to operating cash flows, taxes are an outflow or an inflow, depending on
whether the incremental taxable income is positive or negative. In the case of the
terminal cash flows, there may be a tax on the gain on the sale of the asset for more than
its book value, or there may be a tax benefit (that is, reduce the entire tax bill) if the
asset is sold for less than its book value for tax purposes.
3. Increasing inventory is a cash outflow for any period in which it is increased. However,
we generally assume that the pre-project inventory levels are restored at the end of the
project’s useful life.
11.3 Sensitivity to inputs

1. The benefit of these types of analyses is that the financial manager is able to get an idea
of a worst-case scenario, which is useful for planning purposes (e.g., arranging a line of
credit), and of the best-case scenario (e.g., prepare for effective use of the cash flows
from the project).
2. In simulation analysis, the financial manager can assess risk by allowing all variable
inputs to change based on possible distributions. By examining the results (e.g., IRR) for
a large number of replications, the financial manager will be able to examine the
distribution of possible outcomes.
11.4 Replacement decisions

1. In the case of a replacement decision, the financial manager must consider the cash
flows that would have been derived had the business not replaced the asset, whereas in
the case of an expansion, there are no such cash flows to consider.
2. Cash flows include: depreciation tax shield on the replaced asset, sale proceeds of the
replaced asset (as originally intended and if replaced), and tax on the sale of the
replaced asset, and incremental operating cash flows other than depreciation.
11.5 Inflation and capital budgeting

1. The problem arises because some expenses (e.g., depreciation) do not change with
inflation.
2. Whether inflation makes a project more or less attractive depends on how inflation
affects the company (e.g., income v. expenses).
Answers to Multiple Choice Questions
1. A Sunk costs are costs that would be incurred whether or not a company goes ahead with
the project.
2. A Depreciation tax shield = 0.3 × $30,000 = $9,000
3. B Change in annual cash flow = ($50,000 - 18,000) × (1-0.4) = $19,200
4. A Depreciation tax shield = ($300,000 × 0.20) × 0.40 = $24,000
5. B Operating cash flows are for the actual operations associated with the capital
investment; terminal cash flows occur at the end of the life of the project and relate to
the disposal of the asset or assets.
6. C We calculate this as depreciation × tax rate.

7. A
8. B Cash flow = $20,000 – ($20,000 × 0.35) = $13,000
9. A Investment cash flow = -$400,050 –90,000 + 15,000 – 5000 = $480,050
10. C Investment cash flow = -$120,000 + 75,000 – [0.4 × ($75,000 – 65,000)] = -$49,000
Solutions to Practice Questions and Problems
11.1 Identifying Relevant Cash Flows
11. A sunk cost is an expenditure that is incurred whether or not the investment project under
consideration is accepted or rejected.
12. Investments are made at the margin; that is, the decision is made today to invest addition funds in a
project that produces cash flow into the future. These investments are in addition to the company’s
assets in place, and therefore any taxable income will be taxed at the marginal tax rate, the rate on
the next $1 of taxable income.
13. Taxes enter into the investment decision a number of ways:

• Tax on any gain or loss on the sale of an asset at anything except its book value.
• Investment tax credit, if applicable.
• Tax on additional operating income or a tax benefit from any operating loss.
14. In general, Arturo is correct, but if an investment decision involves the decision or whether to invest
in R&D as part of the decision, then R&D is included.
15. A. No, because this is a sunk cost, incurred whether or not the building is converted.
B. Yes, because if they did not convert the building, it would not incur these expenses.
C. Yes, because if they did not use the building for this project, it would not incur these expenses.
16. A. Sunk cost

B. Opportunity cost
C. Externality
D. Opportunity cost
E. Sunk cost
F. Externality
11.2 Estimating Cash Flows
17. A. -$30,000
B. -$20,000
C. +$1,200 [=$2,000 × (1-0.4)]
D. -$43,000
E. -$5,000
18. A.

3-year MACRS asset

Depreciati Depreciatio
Year on rate Depreciation n tax shield
1 33.33% $166,650 $49,995
2 44.45% $222,250 $66,675
3 14.81% $74,050 $22,215
4 7.41% $37,050 $11,115
5 0% $0 $0
6 0% $0 $0
Total $500,000
B.
5-year MACRS asset
Depreciati
Depreciatio on tax
Year n rate Depreciation shield
1 20.00% $100,000 $30,000
2 32.00% $160,000 $48,000
3 19.20% $96,000 $28,800
4 11.52% $57,600 $17,280
5 11.52% $57,600 $17,280
6 5.76% $28,800 $8,640
Total $500,000
19. The lowering of the tax rates would increase the benefit from higher operating income, but lower
the depreciation tax shield; hence, the effect would depend on the key elements of revenues,
expenses, asset cost, and MACRS life. In general, lowering the tax rate would encourage investment
by increasing cash flows.
20.
5-year MACRS asset
Depreciation Depreciation
Year rate Depreciation tax shield
1 20.00% $200,000 $80,000
2 32.00% $320,000 $128,000
3 19.20% $192,000 $76,800
4 11.52% $115,200 $46,080
5 11.52% $115,200 $46,080
6 5.76% $57,600 $23,040

21.
Initial 1 2 3 4
Inventory $10,000 $12,000 $12,000 $14,000 $10,000
Accounts receivable $12,000 $11,000 $12,000 $13,000 $12,000
Accounts payable $8,000 $9,000 $9,000 $7,000 $8,000
Net working capital $14,000 $14,000 $15,000 $20,000 $14,000
Change in cash flow

Inventory -$2,000 $0 -$2,000 $4,000
Accounts receivable $1,000 -$1,000 -$1,000 $1,000
Accounts payable $1,000 $0 -$2,000 $1,000
Net change in cash flow $0 -$1,000 -$5,000 $6,000
22.
0 1 2 3
Initial cost $50,000
Salvage -$3,000
Useful life 3
Tax rate 35%
MACRS rate 33.33% 44.45% 14.81%
0 1 2 3
Initial outlay -$50,000 -$3,000
Tax on sale of asset $2,347
Change in working capital $5,000 -$5,000 Book value at the time of the sale =
Investment cash flow -$45,000 $0 $0 -$5,653 $50,000 × 7.41% = $3,705
Loss on sale = $3,705
Cost of disposition = $3,000
Total reduction of taxable income =
Change in revenues $25,000 $25,000 $25,000 $3,705 + 3,000 = $6,705
Change in operating Tax benefit from sale = $6,705 × 35%
expenses $12,000 $12,000 $12,000 = $2,346.75
Change in depreciation $16,665 $22,225 $7,405
Change in taxable income -$3,665 -$9,225 $5,595
Change in taxes -$1,283 -$3,229 $1,958
Change in income after tax -$2,382 -$5,996 $3,637
Add: depreciation $16,665 $22,225 $7,405
Operating cash flow $14,283 $16,229 $11,042
Net cash flow -$45,000 $14,283 $16,229 5,389

23. Initial cost $41,500

Salvage $4,000
Useful life 6
Tax rate 40%
Project cost of capital 15%
MACRS rate 33.33% 44.45% 14.81% 7.41% 0.00% 0%
0 1 2 3 4 5 6
Initial outlay -$41,500 $4,000
Tax on sale of asset -$1,600
Change in working
capital -$2,000 $2,000
Investment cash flow -$43,500 $0 $0 $0 $0 $0 $4,400
Operating cash flow $5,600 $5,600 $5,600 $5,600 $5,600 $5,600
$10,00
Net cash flow -$43,500 $5,600 $5,600 $5,600 $5,600 $5,600 0
Net present value -$20,404.66
Change in depreciation $13,832 $18,447 $6,146 $3,075 $0 $0
C.
24. 1 2 3 4 5 6 7 8
Revenues $15,000 $15,750 $16,538 $17,364 $18,233 $19,144 $20,101 $21,107
Operating
Less expenses $7,000 $7,280 $7,571 $7,874 $8,189 $8,517 $8,857 $9,212
Operating
Equals income $8,000 $8,470 $8,966 $9,490 $10,044 $10,628 $11,244 $11,895
Less Taxes $3,200 $3,388 $3,587 $3,796 $4,017 $4,251 $4,498 $4,758
Operating cash
Equals flow $4,800 $5,082 $5,380 $5,694 $6,026 $6,377 $6,747 $7,137
Net present
value of
operating cash
flows $33,169.54
11.3 Sensitivity to Inputs
25. A. This would speed up bringing the cost of the asset into expenses, which would increase the cash
flows earlier in the life of the project.
B. This change would make investment projects more attractive to companies because it increases
the projects’ present value of cash flows (i.e., NPV).

26. A.
Salvage $10,000
Useful life 6
Book value at the Tax rate 40%
end of year 6 is $0.
Gain on sale is
$10,000 - 0 -= MACRS rate 33.33% 44.45% 14.81% 7.41%
$10,000
Tax on gain = 40%
of $10,000 0 1 2 3 4 5 6
Initial outlay -$60,000 $0 $0 $0 $0 $0 $10,000
Change in working
capital $2,000 -$2,000
Investment cash flow -$58,000 $0 $0 $0 $0 $0 $4,000
Change in revenues $70,000 $70,000 $70,000 $70,000 $70,000 $70,000

Change in operating
expenses $40,000 $40,000 $40,000 $40,000 $40,000 $40,000
Change in
depreciation $19,998 $26,670 $8,886 $4,446 $0 $0
Change in taxable
income $10,002 $3,330 $21,114 $25,554 $30,000 $30,000
Change in taxes $4,001 $1,332 $8,446 $10,222 $12,000 $12,000
Change in income
after tax $6,001 $1,998 $12,668 $15,332 $18,000 $18,000
Add: depreciation $19,998 $26,670 $8,886 $4,446 $0 $0
Net cash flow -$58,000 $25,999 $28,668 $21,554 $19,778 $18,000 $22,000
B. Net present value $30,226.25

C. Net present value $37,338.62 Note that the only difference in the NPV
D. Internal rate of return 34.39% function is the discount rate (the first
argument in the =NPV( ) function.
27. A.
Worst Case Scenario
Salvage $0
Useful life 4
Tax rate 45%
MACRS rate 33.33% 44.45% 14.81% 7.41%
0 1 2 3 4
Initial outlay -$500,000 $0 $0 $0 $0
Tax on sale of asset $0

Change in working capital

Investment cash flow -$500,000 $0 $0 $0 $0
Change in revenues $200,000 $200,000 $200,000 $200,000

Change in operating
expenses $160,000 $160,000 $160,000 $160,000
Change in depreciation $166,650 $222,250 $74,050 $37,050
Change in taxable income -$126,650 -$182,250 -$34,050 $2,950
Change in taxes -$56,993 -$82,013 -$15,323 $1,328
Change in income after tax -$69,658 -$100,238 -$18,728 $1,623
Add: depreciation $166,650 $222,250 $74,050 $37,050
Operating cash flow $96,993 $122,013 $55,323 $38,673
Net cash flow -$500,000 $96,993 $122,013 $55,323 $38,673
Most Likely Scenario

Salvage $0
Useful life 4
Tax rate 38%
MACRS rate 33.33% 44.45% 14.81% 7.41%
0 1 2 3 4
Initial outlay -$500,000 $0 $0 $0 $0

Change in operating
expenses $190,000 $190,000 $190,000 $190,000
Change in taxable income -$106,650 -$162,250 -$14,050 $22,950
Change in taxes -$47,993 -$73,013 -$6,323 $10,328
Change in income after tax -$58,658 -$89,238 -$7,728 $12,623
Net cash flow -$500,000 $107,993 $133,013 $66,323 $49,673

Best Case Scenario

Salvage $0
Useful life 4
Tax rate 35%
MACRS rate 33.33% 44.45% 14.81% 7.41%
0 1 2 3 4
Initial outlay -$500,000 $0 $0 $0 $0

Change in operating
expenses $210,000 $210,000 $210,000 $210,000
Change in taxable income -$26,650 -$82,250 $65,950 $102,950
Change in taxes -$11,993 -$37,013 $29,678 $46,328
Change in income after tax -$14,658 -$45,238 $36,273 $56,623
Net cash flow -$500,000 $151,993 $177,013 $110,323 $93,673
B. The new product line is not acceptable under any scenario.
C. The depreciation tax shield adds value to the project, but not enough to overcome the lack of
operating profits.
11.4 Replacement Decisions
28. The depreciation of the replaced asset is relevant because the company would have benefitted from
the depreciation on the replaced asset if it had not been replaced.

29. The contribution is the present value of the change in the depreciation tax shields. We can calculate
this by using two, mathematically equivalent methods:
1. Taking the difference in the depreciation, multiplying each of these differences by the tax
rate, and then discounting these by the discount rate; or
2. Calculating the present value of the depreciation tax shields for both the new and the old
equipment, and then taking the difference of these present values.
1 2 3 4
New equipment $33,330 $44,450 $14,810 $7,410
Old equipment 8,886 8,886 0 0
Difference [new - old] $24,444 $35,564 $14,810 $7,410
Tax rate 40% 40% 40% 40%
Change in depreciation tax shield $9,778 $14,226 $5,924 $2,964
Present value of change in depreciation tax shield = $28,130.78
30. Cash flow associated with replaced asset:
Sales price $10,000

Book value of old 7,410
equipment
Taxable profit $2,590
Cash flow = $10,000 – ($2,590 × tax rate)
31. A.
Salvage $30,000
Useful life 5
Tax rate 40%
MACRS rate New 20% 32% 19.20% 11.52% 11.52%

Old 5.76%
Depreciation
New $20,000 $32,000 $19,200 $11,520 $11,520
Old $2,880 $0 $0 $0 $0
Change $17,120 $32,000 $19,200 $11,520 $11,520
0 1 2 3 4 5
Initial outlay -$100,000
Sale of asset $15,000 $30,000
Tax on sale of asset -$4,848 -$9,696
Change in working capital -$4,000 $4,000
Investment cash flow -$93,848 $0 $0 $0 $0 $24,304

Change in revenues
Change in operating expenses -$20,000 -$20,000 -$20,000 -$20,000 -$20,000
Change in depreciation $17,120 $32,000 $19,200 $11,520 $11,520
Change in taxable income $2,880 -$12,000 $800 $8,480 $8,480
Change in taxes $1,152 -$4,800 $320 $3,392 $3,392
Change in income after tax $1,728 -$7,200 $480 $5,088 $5,088
Add: depreciation $17,120 $32,000 $19,200 $11,520 $11,520
Operating cash flow $18,848 $24,800 $19,680 $16,608 $16,608
Net cash flow -$93,848 $18,848 $24,800 $19,680 $16,608 $40,912
B. Net present value = -$4,685.09

C. Yes, because investing in the project will enhance the value of the company.
11.5 Inflation and Capital Budgeting
32. Inflation affects the cash flows and, hence valuation because while revenues and expenses will
reflect any inflation (or deflation), depreciation expense is at a set amount (i.e., rate x original cost),
which does not reflect changes in purchasing power.
33. A. Net present value = -$1,228.65

Salvage -$5,000
Useful life 6
Tax rate 40%
MACRS rate 33.33% 44.45% 14.81% 7.41% 0.00% 0%
0 1 2 3 4 5 6
Investment cash flow -$92,000 $0 $0 $0 $0 $0 -$1,000
Change in operating expenses $30,000 $30,000 $30,000 $30,000 $30,000 $30,000
-
Change in taxable income -$1,997 $12,005 $14,671 $21,331 $28,000 $28,000
Change in taxes -$799 -$4,802 $5,868 $8,532 $11,200 $11,200
Change in income after tax -$1,198 -$7,203 $8,803 $12,799 $16,800 $16,800
Net cash flow -$92,000 $28,799 $32,802 $22,132 $19,468 $16,800 $15,800
-
Net present value $1,288.65
B. The net present value is positive, NPV = $4,312.56. What changes is that the revenues and

expenses increase relative to the depreciation, which is fixed.

Salvage -$5,000
Useful life 6
Tax rate 40%
0 1 2 3 4 5 6

-
Change in taxes -$799 -$4,354 $6,782 $9,931 $13,102 $13,627
Net cash flow -$92,000 $28,799 $33,474 $23,502 $21,565 $19,654 $19,440
$4,312.5
Net present value 6
C. The net present value is -$287.41. This results from operating expenses increasing at a rate higher than
that of revenues.

Salvage -$5,000
Useful life 6
Tax rate 40%
0 1 2 3 4 5 6


-
Change in taxes -$799 -$4,706 $6,051 $8,792 $11,526 $11,580
Net cash flow -$92,000 $28,799 $32,946 $22,406 $19,857 $17,289 $16,370
Net present value -$287.41
D. For scenarios in part A and B, the project is profitable and therefore should be accepted. In the case of
higher inflation for operating expenses, compared to revenues, the project is not acceptable.
34. A. The net present value is $6,665.12.

Salvage $300,000
Useful life 5
Tax rate 35%
MACRS rate 20% 32% 19.20% 11.52% 11.52%
0 1 2 3 4 5
Initial outlay -$800,000 $300,000
Change in revenues $440,000 $440,000 $440,000 $440,000 $440,000

Change in operating expenses $250,000 $250,000 $250,000 $250,000 $250,000
Change in taxable income $30,000 -$66,000 $36,400 $97,840 $97,840
Change in taxes $10,500 -$23,100 $12,740 $34,244 $34,244
Change in income after tax $19,500 -$42,900 $23,660 $63,596 $63,596
Net cash flow -$800,000 $179,500 $213,100 $177,260 $155,756 $366,884
B. The project is more attractive if revenues and expenses increase with an inflation rate of 3%.


Salvage $300,000
Useful life 5
Tax rate 35%
0 1 2 3 4 5
Initial outlay -$800,000 $300,000

Change in taxes $10,500 -$21,105 $16,790 $40,410 $42,590
Net cash flow -$800,000 $179,500 $216,805 $184,781 $167,208 $382,384
C. The net present value is $44,514.57.

Salvage $300,000
Useful life 5
Tax rate 35%
0 1 2 3 4 5
Initial outlay -$800,000 $300,000

Change in taxes $10,500 -$20,230 $18,584 $43,168 $46,360


Net cash flow -$800,000 $179,500 $218,430 $188,112 $172,330 $389,384
D. For all scenarios of revenue and cost inflation, the project is profitable and therefore should be
accepted.
Solutions to Cases
Case 11.1 The Jam Music Company
A. Yes, because the project provides a positive net present value.
Building cost $900,000
Equipment cost $300,000
Useful life 5
Tax rate 40%
MACRS rates -- 10-year asset 10% 18% 14.40% 11.52% 9.22%
MACRS rates -- 5 year asset 20% 32% 19.20% 11.52% 11.52%
Depreciation: Building $90,000 $162,000 $129,600 $103,680 $82,980
Depreciation: Equipment $60,000 $96,000 $57,600 $34,560 $34,560
Total change in depreciation $150,000 $258,000 $187,200 $138,240 $117,540
0 1 2 3 4 5
Outlay: Building -$900,000 $800,000
Outlay: equipment -$300,000 $150,000
Tax on sale of building -$187,304
Tax on sale of equipment -$53,088
Investment cash flow -$1,300,000 $0 $0 $0 $0 $809,608

Change in taxes $36,000 -$7,200 $21,120 $40,704 $48,984

Net cash flow -$1,300,000 $204,000 $247,200 $218,880 $199,296 $1,000,624
B. Internal rate of return =10.272%

C. No, because the net present value is negative

Useful life 5
Tax rate 40%
0 1 2 3 4 5

Change in taxes $16,000 -$27,200 $1,120 $20,704 $28,984
Net cash flow -$1,300,000 $174,000 $217,200 $188,880 $169,296 $970,624
Internal rate of return 7.604%
D. No, because the net present value is negative

Useful life 5
Tax rate 40%

0 1 2 3 4 5

Change in taxable income $290,000 $32,000 -$9,700 -$45,115 -$87,696
Change in taxes $116,000 $12,800 -$3,880 -$18,046 -$35,079
Change in income after tax $174,000 $19,200 -$5,820 -$27,069 -$52,618
Net cash flow -$1,300,000 $324,000 $277,200 $181,380 $111,171 $874,530
Internal rate of return 9.451%
Case 11.2 Can Tax Credits Make Solar Panels Profitable?

A. Payback period, in months = 524.9 months
Payback period, in years = 43.75 years
B. There is no added value; this is a negative net present value project.
Given inputs
Initial cost, after tax credit $26,247.45
Monthly cash flow $50
After-tax cost of capital
(monthly) 0.1731%
Length of project, in months 360
Calculated values

C. No, because the net present value is negative.
NPV = -$5,826.87
D. 65%
Given inputs
Cost of panels $37,496.36
Using Microsoft’s Excel
Credit (rate) 65%
Solver, we solve for the
Initial cost, after tax credit $13,119.25 rate that results in a $0 net
present value.
Monthly cash flow $50
After-tax cost of capital 0.1731%
Length of project, in months 360
Cost of disposal $500.00

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11.2 Estimating cash flows

11.3 Sensitivity to inputs

Copyright © 2014 John Wiley & Sons, Inc. 11-1

11.4 Replacement decisions

11.5 Inflation and capital budgeting

Integrative Problem: Dazzle

Discussion Questions for Special Features

Concept Review Questions

Copyright © 2014 John Wiley & Sons, Inc. 11-2

11.2 Estimating cash flows

11.3 Sensitivity to inputs

11.4 Replacement decisions

11.5 Inflation and capital budgeting

Answers to Multiple Choice Questions

Copyright © 2014 John Wiley & Sons, Inc. 11-3

Solutions to Practice Questions and Problems

11.1 Identifying Relevant Cash Flows

13. Taxes enter into the investment decision a number of ways:

16. A. Sunk cost

11.2 Estimating Cash Flows

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3-year MACRS asset

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Change in cash flow

Net change in cash flow $0 -$1,000 -$5,000 $6,000

MACRS rate 33.33% 44.45% 14.81%

Net cash flow -$45,000 $14,283 $16,229 5,389

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23. Initial cost $41,500

MACRS rate 33.33% 44.45% 14.81% 7.41% 0.00% 0%

Operating cash flow $5,600 $5,600 $5,600 $5,600 $5,600 $5,600

Net present value -$20,404.66

Change in depreciation $13,832 $18,447 $6,146 $3,075 $0 $0

11.3 Sensitivity to Inputs

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Change in revenues $70,000 $70,000 $70,000 $70,000 $70,000 $70,000

B. Net present value $30,226.25

MACRS rate 33.33% 44.45% 14.81% 7.41%

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Change in working capital

Change in revenues $200,000 $200,000 $200,000 $200,000

Net cash flow -$500,000 $96,993 $122,013 $55,323 $38,673

Net present value -$243,009.77

Most Likely Scenario

Initial cost $500,000

MACRS rate 33.33% 44.45% 14.81% 7.41%

Change in revenues $250,000 $250,000 $250,000 $250,000

Net cash flow -$500,000 $107,993 $133,013 $66,323 $49,673

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Net present value -$208,141.25

Best Case Scenario

Initial cost $500,000

MACRS rate 33.33% 44.45% 14.81% 7.41%

Change in revenues $350,000 $350,000 $350,000 $350,000

Net cash flow -$500,000 $151,993 $177,013 $110,323 $93,673

Net present value -$68,667.17

B. The new product line is not acceptable under any scenario.

11.4 Replacement Decisions

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