determine the initial investment outlay

determine the initial investment outlay

Subject: Business    / Finance   
Question

11.1 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 40%.

a. What is the initial investment 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

$1.5 million after taxes and real estate commissions. How would this affect your

answer?

11.2 The financial staff of Cairn Communications has identified the following information for

the first year of the roll-out of its new proposed service:

Projected sales- $18 million

Operating costs (not including depreciation)- $ 9 million

Depreciation- $ 4 million

Interest expense- $ 3 million

The company faces a 40% tax rate. What is the project’s operating cash flow for the first

year (t = 1)?

11.3 Allen Air Lines must liquidate some equipment that is being replaced. The equipment

originally cost $12 million, of which 75% has been depreciated. The used equipment can

be sold today for $4 million, and its tax rate is 40%. What is the equipment’s after-tax net

salvage value?

11.6- The Campbell Company is considering adding a robotic paint sprayer to its

production line. The sprayer’s base price is $1,080,000, and it would cost another

$22,500 to install it. The machine falls into the MACRS 3-year class, and it would be

sold after 3 years for $605,000. The MACRS rates for the first three years are 0.3333,

0.4445, and 0.1481. The machine would require an increase in net working capital

(inventory) of $15,500. The sprayer would not change revenues, but it is expected to

save the firm $380,000 per year in before-tax operating costs, mainly labor.

Campbell’s marginal tax rate is 35%.

a. What is the Year 0 net cash flow?

b. What are the net operating cash flows in Years 1, 2, and 3?

c. What is the additional Year-3 cash flow (i.e., the after-tax salvage and the return of

working capital)?

d. If the project’s cost of capital is 12%, should the machine be purchased?

16.2 Medwig Corporation has a DSO of 17 days. The company averages $3,500 in credit sales

each day. What is the company’s average accounts receivable?

16.6 Snider Industries sells on terms of 2/10, net 45. Total sales for the year are $1,500,000.

Thirty percent of customers pay on the 10th day and take discounts; the other 70% pay,

on average, 50 days after their purchases.

a. What is the days sales outstanding?

b. What is the average amount of receivables?

c. What would happen to average receivables if Snider toughened its collection policy

with the result that all nondiscount customers paid on the 45th day?

16.7 Calculate the nominal annual cost of nonfree trade credit under each of the following

terms. Assume that payment is made either on the discount date or on the due date.

a. 1/15, net 20

b. 2/10, net 60

c. 3/10, net 45

d. 2/10, net 45

e. 2/15, net 40

16.9 Grunewald Industries sells on terms of 2/10, net 40. Gross sales last year were $4,562,500

and accounts receivable averaged $437,500. Half of Grunewald’s customers paid on the

10th day and took discounts. What are the nominal and effective costs of trade credit to

Grunewald’s nondiscount customers? (Hint: Calculate daily sales based on a 365-day year,

then calculate average receivables of discount customers, and then find the DSO for the

nondiscount customers.)

16.11 Negus Enterprises has an inventory conversion period of 50 days, an average collection

period of 35 days, and a payables deferral period of 25 days. Assume that cost of goods

sold is 80% of sales.

a. What is the length of the firm’s cash conversion cycle?

b. If Negus’s annual sales are $4,380,000 and all sales are on credit, what is the firm’s

investment in accounts receivable?

c. How many times per year does Negus Enterprises turn over its inventory?