Chapter 8

Capital Budgeting Cash Flows

Solutions to Problems

Note: The MACRS depreciation percentages used in the following problems appear in Chapter 3,
Table 3.2. The percentages are rounded to the nearest integer for ease in calculation.
For simplification, five-year-lived projects with 5 years of cash inflows are used throughout this chapter.
Projects with usable lives equal to the number of years of cash inflows are also included in the end-ofchapter problems. It is important to recall from Chapter 3 that, under the Tax Reform Act of 1986,
MACRS depreciation results in n + 1 years of depreciation for an n-year class asset. This means that in
actual practice projects will typically have at least one year of cash flow beyond their recovery period.
P8-1.

LG 1: Classification of Expenditures
Basic
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)

P8-2.

Operating expenditure
Capital expenditure
Capital expenditure
Operating expenditure
Capital expenditure
Capital expenditure
Capital expenditure
Operating expenditure

LG 2: Basic Terminology
Basic
(a)
(b)
(c)
(d)

Situation A

Situation B

mutually exclusive
unlimited
ranking
conventional

mutually exclusive
unlimited
accept-reject
nonconventional

Situation C
independent
capital rationing
ranking
conventional (2&4)
nonconventional (1&3)

194

P8-3.

Part 3 Long-Term Investment Decisions

LG 3: Relevant Cash Flow Pattern Fundamentals

Intermediate
(a) Year
Initial investment
118
0

$25,000 $5,000

120,000 20,000

55,000 20,000
(c) Initial investment
15
6
710
0
1

P8-4.

20,000

(b) Initial investment

15
6
0
1

2,000,000

Cash Flow
($120,000)
= $20,000

280,000

16

20,000 ------------------- 20,000

($85,000 $30,000)

$20,000 + $20,000 $10,000

3
4
5

20,000

20,000

20,000

$300,000 $20,000
$300,000 $500,000
$300,000 $20,000
2
5
280,000 280,000

20,000

200,000

17

18

20,000

20,000

= ($55,000)
= $20,000
= $30,000
6
30,000
($2,000,000)
=
$280,000
=
($200,000)
=
280,000
7
10
280,000 280,000

LG 3: Expansion versus Replacement Cash Flows

Intermediate
(a)
Year
Initial investment
1
2
3
4
5

Relevant Cash Flows

($28,000)
4,000
6,000
8,000
10,000
4,000

(b) An expansion project is simply a replacement decision in which all cash flows from the old
asset are zero.

Chapter 8

P8-5.

Capital Budgeting Cash Flows

195

LG 3: Sunk Costs and Opportunity Costs

Basic
(a) The $1,000,000 development costs should not be considered part of the decision to go ahead
with the new production. This money has already been spent and cannot be retrieved so it is a
sunk cost.
(b) The $250,000 sale price of the existing line is an opportunity cost. If Masters Golf Products
does not proceed with the new line of clubs they will not receive the $250,000.
(c)
Cash Flows
$1,800,000 $750,000 $750,000 $750,000
$750,000
$750,000
+ $250,000
||||||>
0
1
2
3
9
10
End of Year

P8-6.

LG 3: Sunk Costs and Opportunity Costs

Intermediate
(a)
(b)

(c)
(d)

(e)
P8-7.

Sunk costThe funds for the tooling had already been expended and would not change, no
matter whether the new technology would be acquired or not.
Opportunity costThe development of the computer programs can be done without
additional expenditures on the computers; however, the loss of the cash inflow from the
leasing arrangement would be a lost opportunity to the firm.
Opportunity costCovol will not have to spend any funds for floor space but the lost cash
inflow from the rent would be a cost to the firm.
Sunk costThe money for the storage facility has already been spent, and no matter what
decision the company makes there is no incremental cash flow generated or lost from the
storage building.
Opportunity costForegoing the sale of the crane costs the firm $180,000 of potential cash
inflows.

LG 4: Book Value
Basic
Asset

Installed
Cost

Accumulated
Depreciation

Book
Value

A
B
C
D
E

$950,000
40,000
96,000
350,000
1,500,000

$674,500
13,200
79,680
70,000
1,170,000

$275,500
26,800
16,320
280,000
330,000

196

P8-8.

Part 3 Long-Term Investment Decisions

LG 4: Book Value and Taxes on Sale of Assets

Intermediate
(a)

Book value = $80,000 (0.71 $80,000)

= $23,200

(b)

P8-9.

Sale Price

Capital
Gain

Tax on
Capital Gain

Depreciation
Recovery

Tax on
Recovery

Total
Tax

$100,000
56,000
23,200
15,000

$20,000
0
0
0

$8,000
0
0
0

$56,800
32,800
0
(8,200)

$22,720
13,120
0
(3,280)

$30,720
13,120
0
(3,280)

LG 4: Tax Calculations
Intermediate
Current book value = $200,000 [(0.52 ($200,000)] = $96,000
Capital gain
Recaptured depreciation
Tax on capital gain
Tax on depreciation
recovery
Total tax

(a)

(b)

(c)

(d)

$20,000
104,000
$8,000

0
54,000
0

0
0
0

0
(16,000)
0

41,600
$49,600

21,600
$21,600

0
$0

(6,400)
($6,400)

P8-10. LG 4: Change in Net Working Capital Calculation

Basic
(a)
Current Assets
Cash
Accounts receivable
Inventory
Net change

Current Liabilities
+$15,000
+150,000
10,000
$155,000

Accounts payable
Accruals

+$90,000
+40,000
$130,000

Net working capital = current assets current liabilities

NWC = $155,000 $130,000
NWC = $25,000
(b) Analysis of the purchase of a new machine reveals an increase in net working capital. This
increase should be treated as an initial outlay and is a cost of acquiring the new machine.
(c) Yes, in computing the terminal cash flow, the net working capital increase should be
reversed.

Chapter 8 Capital Budgeting Cash Flows

P8-11. LG 4: Calculating Initial Investment

Intermediate
(a)
(b)

Book value = ($325,000 0.48) = $156,000

Sales price of old equipment
$200,000
Book value of old equipment
156,000
Recapture of depreciation
$44,000
Taxes on recapture of depreciation = $44,000 0.40 = $17,600
After-tax proceeds = $200,000 $17,600 = $182,400

(c)

Cost of new machine

Less sales price of old machine
Plus tax on recapture of depreciation
Initial investment

$500,000
(200,000)
17,600
$317,600

P8-12. LG 4: Initial InvestmentBasic Calculation

Intermediate
Installed cost of new asset =
Cost of new asset
$35,000
+ Installation Costs
5,000
Total installed cost (depreciable value)
After-tax proceeds from sale of old asset =
Proceeds from sale of old asset
($25,000)
+ Tax on sale of old asset
7,680
Total after-tax proceeds-old asset
Initial investment

$40,000

($17,320)
$22,680

Book value of existing machine = $20,000 (1 (0.20 + 0.32 + 0.19)) = $5,800

Recaptured depreciation = $20,000 $5,800 = $14,200
Capital gain
= $25,000 $20,000 = $5,000
Tax on recaptured depreciation = $14,200 (0.40) = $5,680
Tax on capital gain
= $5,000 (0.40) = 2,000
Total tax
=
$7,680

197

198

Part 3 Long-Term Investment Decisions

P8-13. LG 4: Initial investment at Various Sale Prices

Intermediate
Installed cost of new asset:
Cost of new asset
+ Installation cost
Total installed-cost
After-tax proceeds from sale
of old asset
Proceeds from sale
of old asset
+ Tax on sale of old asset*
Total after-tax proceeds
Initial investment

(a)

(b)

(c)

(d)

$24,000
2,000
$26,000

$24,000
2,000
$26,000

$24,000
2,000
$26,000

$24,000
2,000
$26,000

(11,000)
3,240
(7,760)
$18,240

(7,000)
1,640
(5,360)
$20,640

(2,900)
0
(2,900)
$23,100

(1,500)
(560)
(2,060)
$23,940

Book value of existing machine = $10,000 [1 (0.20 0.32 0.19)] = $2,900

*

Tax Calculations:
(a) Recaptured depreciation = $10,000 $2,900 = $7,100
Capital gain
= $11,000 $10,000 = $1,000
Tax on ordinary gain
Tax on capital gain
Total tax

= $7,100 (0.40)
= $1,000 (0.40)
=

(b) Recaptured depreciation = $7,000 $2,900

Tax on ordinary gain
= $4,100 (0.40)

= $2,840
=
400
$3,240
= $4,100
= $1,640

(c) 0 tax liability

(d) Loss on sale of existing asset = $1,500 $2,900 = ($1,400)
Tax benefit
= $1,400 (0.40) =
$560

P8-14. LG 4: Calculating Initial Investment

Challenge
(a)

Book value = ($60,000 0.31) = $18,600

(b) Sales price of old equipment

Book value of old equipment
Recapture of depreciation

$35,000
18,600
$16,400

Taxes on recapture of depreciation = $16,400 0.40 = $6,560

Sale price of old roaster
$35,000
Tax on recapture of depreciation
(6,560)
After-tax proceeds from sale of old roaster $28,440

Chapter 8 Capital Budgeting Cash Flows

(c) Changes in current asset accounts

Inventory
Accounts receivable
Net change

$50,000
70,000
$120,000

Changes in current liability accounts

Accruals
Accounts payable
Notes payable
Net change

$(20,000)
40,000
15,000
$35,000

Change in net working capital

$85,000

(d) Cost of new roaster

$130,000
Less after-tax proceeds from sale of old roaster
28,440
Plus change in net working capital
85,000
Initial investment
$186,560
P8-15. LG 4: Depreciation
Basic
Depreciation Schedule
Year
Depreciation Expense
1
2
3
4
5
6

$68,000
68,000
68,000
68,000
68,000
68,000

0.20 = $13,600
0.32 = 21,760
0.19 = 12,920
0.12 = 8,160
0.12 = 8,160
0.05 = 3,400

P8-16. LG 5: Incremental Operating Cash Inflows

Intermediate
(a)

Incremental profits before tax and depreciation = $1,200,000 $480,000

= $720,000 each year

(b)
Year
PBDT
Depr.
NPBT
Tax
NPAT
(c)

(1)

(2)

(3)

(4)

(5)

(6)

$720,000
400,000
320,000
128,000
192,000

$720,000
640,000
80,000
32,000
48,000

$720,000
380,000
340,000
136,000
204,000

$720,000
240,000
480,000
192,000
288,000

$720,000
240,000
480,000
192,000
288,000

$720,000
100,000
620,000
248,000
372,000

Cash
(1)
(2)
flow $592,000 $688,000
(NPAT + depreciation)

(3)
$584,000

(4)
$528,000

PBDT = Profits before depreciation and taxes

NPBT = Net profits before taxes
NPAT = Net profits after taxes

(5)
$528,000

(6)
$472,000

199

200

Part 3 Long-Term Investment Decisions

P8-17. LG 5: Incremental Operating Cash InflowsExpense Reduction

Intermediate
Year
Incremental
expense savings
Incremental profits
before dep. and taxes*
Depreciation
Net profits
before taxes
Taxes
Net profits
after taxes
Operating cash
inflows**
*
**

(1)

(2)

(3)

(4)

(5)

(6)

$16,000

$16,000

$16,000

$16,000

$16,000

$0

$16,000
9,600

$16,000
15,360

$16,000
9,120

$16,000
5,760

$16,000
5,760

$0
2,400

6,400
2,560

640
256

6,880
2,752

10,240
4,096

10,240
4,096

2,400
960

3,840

384

4,128

6,144

6,144

1,440

13,440

15,744

13,248

11,904

11,904

960

Incremental profits before depreciation and taxes will increase the same amount as the decrease in expenses.
Net profits after taxes plus depreciation expense.

P8-18. LG 5: Incremental Operating Cash Inflows

Intermediate
(a)

Year

Revenue

Expenses
(excluding
depreciation
and interest)

$40,000
41,000
42,000
43,000
44,000
0

$30,000
30,000
30,000
30,000
30,000
0

$10,000
11,000
12,000
13,000
14,000
0

$2,000
3,200
1,900
1,200
1,200
500

$8,000
7,800
10,100
11,800
12,800
(500)

$3,200
3,120
4,040
4,720
5,120
(200)

$4,800
4,680
6,060
7,080
7,680
(300)

$6,800
7,880
7,960
8,280
8,880
200

$35,000

$25,000

$10,000

$10,000

$4,000

$6,000

$6,000

Profits Before
Depreciation Depreand Taxes
ciation

Net
Profits
Before
Taxes

Net
Profits
Taxes

Net
Operating
Profits
Cash
After Tax Inflows

New Lathe
1
2
3
4
5
6
Old Lathe
15

Chapter 8 Capital Budgeting Cash Flows

(b) Calculation of Incremental Cash Inflows

Year
New Lathe
Old Lathe

Incremental Cash Flows

$6,800

$6,000

$800

7,880

6,000

1,880

7,960

6,000

1,960

8,280

6,000

2,280

8,880

6,000

2,880

200

200

(c)

|
0

$800
|
1

Cash Flows
$1,960
$2,280
|
|
3
4
End of Year

$1,880
|
2

$2,880
|
5

$200
|
6

P8-19. LG 5: Determining Operating Cash Flows

Intermediate
(a)
Year
1
Revenues:(000)
New buses
$1,850
Old buses
1,800
Incremental revenue
$50
Expenses: (000)
New buses
$460
Old buses
500
Incremental expense
$(40)
Depreciation: (000)
New buses
$600
Old buses
324
Incremental depr.
$276
Incremental depr. tax
savings @40%
110
Net Incremental Cash Flows
Cash Flows: (000)
Revenues
$50
Expenses
40
Less taxes @40%
(36)
Depr. tax savings
110
Net operating cash
inflows
$164

$1,850
1,800
$50

$1,830
1,790
$40

$1,825
1,785
$40

$1,815
1,775
$40

$1,800
1,750
$50

$460
510
$(50)

$468
520
$(52)

$472
520
$(48)

$485
530
$(45)

$500
535
$(35)

$960
135
$825

$570
0
$570

$360
0
$360

$360
0
$360

$150
0
$150

330

228

144

144

60

$50
50
(40)
330

$40
52
(37)
228

$40
48
(35)
144

$40
45
(34)
144

$50
35
(34)
60

$390

$283

$197

$195

$111

201

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Part 3 Long-Term Investment Decisions

P8-20. LG 6: Terminal Cash FlowsVarious Lives and Sale Prices

Challenge
(a)
After-tax proceeds from sale of new asset = 3-year*
Proceeds from sale of proposed asset
$10,000
*
+16,880
Tax on sale of proposed asset
Total after-tax proceeds-new
$26,880
+ Change in net working capital
+30,000
Terminal cash flow
$56,800
*

(1) Book value of asset

Proceeds from sale
$10,000 $52,200
$42,200 (0.40)

5-year*
$10,000
400
$9,600
+30,000
$39,600

7-year*
$10,000
4,000
$6,000
+30,000
$36,000

= [1 (0.20 + 0.32 + 0.19) ($180,000)] = $52,200

= $10,000
= ($42,200) loss
= $16,880 tax benefit

(2) Book value of asset = [1 (0.20 + 0.32 + 0.19 + 0.12 + 0.12) ($180,000)] = $9,000
$10,000 $9,000 = $1,000 recaptured depreciation
$1,000 (0.40)
= $400 tax liability
(3) Book value of asset = $0
$10,000 $0
= $10,000 recaptured depreciation
$10,000 (0.40)
= $4,000 tax liability

(b) If the usable life is less than the normal recovery period, the asset has not been depreciated
fully and a tax benefit may be taken on the loss; therefore, the terminal cash flow is higher.
(c)
(1)
(2)
After-tax proceeds from sale of new asset =
Proceeds from sale of new asset
$9,000
$170,000
*
+ Tax on sale of proposed asset
0
(64,400)
+ Change in net working capital
+30,000
+30,000
Terminal cash flow
$39,000
$135,600
*

(1) Book value of the asset = $180,000 0.05 = $9,000; no taxes are due
(2) Tax = ($170,000 $9,000) 0.4 = $64,400.

(d) The higher the sale price, the higher the terminal cash flow.

Chapter 8 Capital Budgeting Cash Flows

P8-21. LG 6: Terminal Cash FlowReplacement Decision

Challenge
After-tax proceeds from sale of new asset =
Proceeds from sale of new machine
$75,000
(14,360)
Tax on sale of new machine l
Total after-tax proceeds-new asset
After-tax proceeds from sale of old asset
Proceeds from sale of old machine
(15,000)
6,000
+ Tax on sale of old machine 2
Total after-tax proceeds-old asset
+ Change in net working capital
Terminal cash flow

$60,640

(9,000)
25,000
$76,640

Book value of new machine at end of year.4:

[1 (0.20 + 0.32+ 0.19 + 0.12) ($230,000)] = $39,100
$75,000 $39,100
= $35,900 recaptured depreciation
$35,900 (0.40)
= $14,360 tax liability

Book value of old machine at end of year 4:

$0
$15,000 $0
= $15,000 recaptured depreciation
$15,000 (0.40)
= $6,000 tax benefit

203

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Part 3 Long-Term Investment Decisions

P8-22. LG 4, 5, 6: Relevant Cash Flows for a Marketing Campaign

Challenge
Marcus Tube
Calculation of Relevant Cash Flow
($000)
Calculation of Net Profits after Taxes and Operating Cash Flow:
with Marketing Campaign
2007
Sales
CGS (@ 80%)
Gross Profit
Less: Operating Expenses
General and
Administrative
(10% of sales)
Marketing Campaign
Depreciation
Total operating
expenses
Net profit
before taxes
Less: Taxes 40%
Net profit
after taxes
+Depreciation
Operating CF

2008

2009

$21,000
16,800
$4,200

$21,500
17,200
$4,300

$22,500
18,000
$4,500

$23,500
18,800
$4,700

$2,050
150
500

$2,100
150
500

$2,150
150
500

$2,250
150
500

$2,350
150
500

2,700

2,750

2,800

2,900

3,000

$1,400
560

$1,450
580

$1,500
600

$1,600
640

$1,700
680

$840
500
$1,340

$870
500
$1,370

$900
500
$1,400

$960
500
$1,460

$1,020
500
$1,520

$900
500
$1,400
Relevant Cash Flow
($000)

Year
2007
2008
2006
2010
2011

With Marketing
Campaign
$1,340
1,370
1,400
1,460
1,520

2011

$20,500
16,400
$4,100

Without Marketing Campaign

Years 20072011
Net profit after taxes
+ Depreciation
Operating cash flow

2010

Without Marketing Incremental

Campaign
Cash Flow
$1,400
1,400
1,400
1,400
1,400

$(60)
(30)
0
60
120

Chapter 8 Capital Budgeting Cash Flows

P8-23. LG 4, 5: Relevant Cash FlowsNo Terminal Value

Challenge
(a)

Installed cost of new asset

Cost of new asset
$76,000
+ Installation costs
4,000
Total cost of new asset
After-tax proceeds from sale of old asset
Proceeds from sale of old asset
(55,000)
*
16,200
+ Tax on sale of old asset
Total proceeds, sale of old asset
Initial investment
Book value of old machine:
[1 (0.20 + 0.32 + 0.19)] $50,000
$55,000 $14,500

$80,000

(38,800)
$41,200

= $14,500
= $40,500 gain on asset

$35,500 recaptured depreciation 0.40 = $14,200

$5,000 capital gain 0.40
=
2,000
Total tax on sale of asset
= $16,200

(b)

Calculation of Operating Cash Flow

Year

(1)

(2)

(3)

(4)

(5)

(6)

Old Machine
PBDT
Depreciation
NPBT
Taxes
NPAT
Depreciation
Cash flow

$14,000
6,000
$8,000
3,200
$4,800
6,000
$10,800

$16,000
6,000
$10,000
4,000
$6,000
6,000
$12,000

$20,000
2,500
$17,500
7,000
$10,500
2,500
$13,000

$18,000
0
$18,000
7,200
$10,800
0
$10,800

$14,000
0
$14,000
5,600
$8,400
0
$8,400

$0
0
0
0
$0
0
$0

$30,000

$30,000

$30,000

$30,000

$30,000

$0

16,000

25,600

15,200

9,600

9,600

4,000

NPBT

$14,000

$4,400

$14,800

$20,400

$20,400

$4,000

Taxes

5,600

1,760

5,920

8,160

8,160

1,600

NPAT

$8,400

$2,640

$8,880

$12,240

$12,240

$2,400

Depreciation

16,000

25,600

15,200

9,600

9,600

4,000

$24,400

$28,240

$24,080

$21,840

$21,840

$1,600

New Machine
PBDT
Depreciation

Cash flow
Incremental
After-tax
Cash flows

$13,600

$16,240

$11,080

$11,040

$13,440

$1,600

205

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Part 3 Long-Term Investment Decisions

(c)
$41,200
|
0

$13,600
|
1

Cash Flows
$16,240
$11,080
|
|
2
3
End of Year

$11,040
|
4

$13,440
|
5

P8-24. LG 4, 5, 6: IntegrativeDetermining Relevant Cash Flows

Challenge
(a)

Initial investment:
Installed cost of new asset =
Cost of new asset
$105,000
+ Installation costs
5,000
Total cost of new asset
After-tax proceeds from sale of old asset =
Proceeds from sale of old asset
(70,000)
*
16,480
+ Tax on sale of old asset
Total proceeds from sale of old asset
+ Change in working capital
Initial investment
*

Book value of old asset:

[1 (0.20 + 0.32)] $60,000

= $28,800

$70,000 $28,800 = $41,200 gain on sale of asset

$31,200 recaptured depreciation 0.40 = $12,480
$10,000 capital gain 0.40
= 4,000
Total tax of sale of asset
= $16,480

$110,000

(53,520)
12,000
$68,480

$1,600
|
6

Chapter 8 Capital Budgeting Cash Flows

207

(b)
Calculation of Operating Cash Inflows

Year

Profits Before
Depreciation
Net Profits
Net Profits
and Taxes
Depreciation Before Taxes Taxes After Taxes

New Grinder
1
2
3
4
5
6

$43,000
43,000
43,000
43,000
43,000
0

$22,000
35,200
20,900
13,200
13,200
5,500

$21,000
7,800
22,100
29,800
29,800
5,500

$8,400
3,120
8,840
11,920
11,920
2,200

$12,600
4,680
13,260
17,880
17,880
3,300

$34,600
39,880
34,160
31,080
31,080
2,200

Existing Grinder
1
$26,000
2
24,000
3
22,000
4
20,000
5
18,000
6
0

$11,400
7,200
7,200
3,000
0
0

$14,600
16,800
14,800
17,000
18,000
0

$5,840
6,720
5,920
6,800
7,200
0

$8,760
10,080
8,880
10,200
10,800
0

$20,160
17,280
16,080
13,200
10,800
0

Year
1
2
3
4
5
6
(c)

Operating
Cash
Inflows

Calculation of Incremental Cash Inflows

Incremental Operating
New Grinder Existing Grinder
Cash Flow
$34,600
39,880
34,160
31,080
31,080
2,200

$20,160
17,280
16,080
13,200
10,800
0

$14,440
22,600
18,080
17,880
20,280
2,200

Terminal Cash Flow:

After-tax proceeds from sale of new asset =
Proceeds from sale of new asset
$29,000
*
(9,400)
Tax on sale of new asset
Total proceeds from sale of new asset
After-tax proceeds from sale of old asset =
Proceeds from sale of old asset
0
+ Tax on sale of old asset
0
Total proceeds from sale of old asset
+ Change in net working capital
Terminal cash flow
*

19,600

0
12,000
$31,600

Book value of asset at end of year 5 = $5,500

$29,000 $5,500
= $23,500 recaptured depreciation
$23,500 0.40
= $9,400

208

Part 3 Long-Term Investment Decisions

(d) Year 5 Relevant Cash Flow:

Operating cash flow
Terminal cash flow
Total inflow
0
1
2
68,480

14,400

22,600

$20,280
31,600
$51,880
3
18,080

4
17,880

5
51,880

6
2,200

P8-25. LG 4, 5, 6: IntegrativeDetermining Relevant Cash Flows

Challenge
(a)
Initial investment
Installed cost of new asset
Cost of new asset
+ Installation costs
Total proceeds, sale of new asset
After-tax proceeds from sale of old asset
Proceeds from sale of old asset
+ Tax on sale of old asset *
Total proceeds, sale of old asset
+ Change in working capital
Initial investment
*

Book value of old asset:

[1 (0.20 + 0.32 + 0.19)] ($32,000) = $9,280

$40,000
8,000

$54,000
6,000
48,000

(18,000)
3,488

60,000
(18,000)
3,488

(14,512)
4,000
$37,488

(14,512)
6,000
$51,488

Chapter 8

(b)

Capital Budgeting Cash Flows

209

Calculation of Operating Cash Inflows

Profits
Before
Depreciation
and Taxes

Year

Depreciation

Net Profits
Before
Taxes

Taxes

Net Profits Operating

After
Cash
Taxes
Inflows

Hoist A
1
2
3
4
5
6

$21,000
21,000
21,000
21,000
21,000
0

$9,600
15,360
9,120
5,760
5,760
2,400

$11,400
5,640
11,880
15,240
15,240
2,400

$4,560
2,256
4,752
6,096
6,096
960

$6,840
3,384
7,128
9,144
9,144
1,440

$16,440
18,744
16,248
14,904
14,904
960

Hoist B
1
2
3
4
5
6

$22,000
24,000
26,000
26,000
26,000
0

$12,000
19,200
11,400
7,200
7,200
3,000

$10,000
4,800
14,600
18,800
18,800
3,000

$4,000
1,920
5,840
7,520
7,520
1,200

$6,000
2,880
8,760
11,280
11,280
1,800

18,000
22,080
20,160
18,480
18,480
1,200

Existing Hoist
1
2
3
4
5
6

$14,000
14,000
14,000
14,000
14,000
0

$3,840
3,840
1,600
0
0
0

$10,160
10,160
12,400
14,000
14,000
0

$4,064
4,064
4,960
5,600
5,600
0

$6,096
6,096
7,440
8,400
8,400
0

$9,936
9,936
9,040
8,400
8,400
0

Year
1
2
3
4
5
6

Hoist A
$16,440
18,744
16,248
14,904
14,904
960

Calculation of Incremental Cash Inflows

Incremental
Hoist B
Existing Hoist
Hoist A
$18,000
22,080
20,160
18,480
18,480
1,200

$9,936
9,936
9,040
8,400
8,400
0

$6,504
8,808
7,208
6,504
6,504
960

Cash Flow
Hoist B
$8,064
12,144
11,120
10,080
10,080
1,200

210

Part 3 Long-Term Investment Decisions

(c) Terminal Cash Flow:

(A)
After-tax proceeds form sale of new asset
Proceeds from sale of new asset
Tax on sale of new asset l
Total proceeds-new asset
After-tax proceeds from sale of old asset
Proceeds from sale of old asset
+ Tax on sale of old asset 2
Total proceeds-old asset
+ Change in net working capital
Terminal cash flow
1

(B)

$12,000
(3,840)

$20,000
(6,800)
8,160

(1,000)
400

13,200
(1,000)
400

(600)
4,000
$11,560

(600)
6,000
$18,600

Book value of Hoist A at end of year 5 = $2,400

$12,000 $2,400 = $9,600 recaptured depreciation
$9,600 0.40
= $3,840 tax
Book value of Hoist B at end of year 5 = $3,000
$20,000 $3,000 = $17,000 recaptured depreciation
$17,000 0.40 = $6,800 tax

Book value of Existing Hoist at end of year 5 = $0

$1,000 $0
= $1,000 recaptured depreciation
$1,000 0.40
= $400 tax
Year 5 Relevant Cash FlowHoist A:
Operating cash flow
Terminal cash flow
Total inflow

$6,504
11,560
$18,064

Year 5 Relevant Cash Flow - Hoist B:

Operating cash flow
Terminal cash flow
Total inflow

$10,080
18,600
$28,680

(d)
Hoist A
Cash Flows
$37,488
|
0

$6,504
|
1

$8,808
|
2

$7,208
|
3
End of Year

$6,504
|
4

$18,064
|
5

$960
|
6

$10,080
|
4

$28,680
|
5

$1,200
|
6

Hoist B
Cash Flows
$51,488
|
0

$8,064
|
1

$12,144
|
2

$11,120
|
3
End of Year

Chapter 8

Capital Budgeting Cash Flows

P8-26. Ethics Problem

Intermediate
The likely explanation is that loan officers and bank credit analysts are often more preoccupied
with a firms ability to repay the loan and how soon rather then internal rate of return of the
project or its discounted cash flow. Another reason is maybe that owners or managers of small
businesses may not have sufficient skills to conduct the more tedious financial analysis.

211