Question

Question #1

a) A firm has an asset with a market value of $20,000 and a book value of $30,000. If its marginal tax rate is 25%, what will the net proceeds from selling the asset be?

b) A firm has an asset with a market value of $10,000 and a book value of $4,000. If its marginal tax rate is 25%, what will the net proceeds from selling the asset be?

Question #2

A firm believes it can generate an additional $2,000,000 per year in revenues for the next 5 years if it purchases a new piece of equipment for $1,000,000. The firm does not expect to be able to sell the new equipment when it is finished using it (after 5 years). Variable costs are expected to be 48% of revenue annually. Assuming the firm uses straight-line depreciation and its marginal tax rate is 25%, what are the incremental annual operating cash flows of this acquisition?

Question #3

A firm believes it can generate an additional $4,000,000 per year in revenues for the next 10 years if it replaces existing equipment that is no longer usable with new equipment that costs $6,500,000. The existing equipment has a book value of $50,000 and a market value of $20,000. The firm expects to be able to sell the new equipment when it is finished using it (after 10 years) for $100,000. Variable costs are expected to be 54% of revenue annually. The additional sales will require an initial investment in net working capital of $400,000, which is expected to be recovered at the end of the project (after 10 years). Assume the firm uses straight-line depreciation, its marginal tax rate is 25%, and the discount rate for the project is 14%.

a) How much value will this new equipment create for the firm?

b) At what discount rate will this project break even?

c) Should the firm purchase the new equipment? Be sure to justify your recommendation.

d) How would your analysis change if the firm believes the project is more risky than initially expected? Be specific.

Answer 1

1. a
i	Market Value	$              20,000
ii	Book Value	$              30,000
iii	Profit/(Loss) (i-ii)	$            (10,000)
iv	Tax Rate	25%
v	Tax	-
vi	Net Proceeds from Selling (i-v)	20,000.00
1. b
i	Market Value	$              10,000
ii	Book Value	$                4,000
iii	Profit/(Loss) (i-ii)	$                6,000
iv	Tax Rate	25%
v	Tax	1,500.00
vi	Net Proceeds from Selling (i-v)	8,500.00
Q.2
	Particulars	Amount
	Revenue Generated	$        2,000,000
Less:	Variable Costs (48%)	$            960,000
	Depreciation ($10,00,000/5 Years)	$            200,000
	Profit	$            840,000
	Tax Rate	25%
	Tax	$            210,000
	Profit After Tax	$            630,000
Add:	Depreciation	$            200,000
	Cash Flow After Tax ( Annually)	$            830,000
Q.3
	Particulars	Amount
	a.Revenue Generated	$        4,000,000
Less:	b.Variable Costs (48%)	$        2,160,000
	c.Depreciation (Note Provided)	$            640,000
	Profit	$        1,200,000
	d.Tax Rate	25%
	e.Tax	$            300,000
	f.Profit After Tax	$            900,000
Add:	g.Depreciation	$            640,000
	h.Cash Flow After Tax ( Annually)	$        1,540,000
	i. PVAF ( 14% ,10 Years)	5.2161
	j. Discounted Value of Cash Flow	$        8,032,794
	k. Salvage Value of Equipment	$            100,000
	l. Discounted Value	$              26,970
	m. Discounted Cash inflow (h*i)	$        8,059,764
	n. Initial Cash Outflow ( Note Provided)	$        6,380,000
	o. Net Present Value (m-o)	$        1,679,764

	Note : Depreciation and Cash Outflow
	Equipments Cost	$        6,500,000
Less :	Salvage Value	$            100,000
	Market Value of current old equipment	$              20,000
	Net Cash Outflow	$        6,380,000
	Life of Equipment	10 years
	Depreciation	$            640,000

a.	How Much Value will this equipment create for firm	$                                                         1,679,764
b.	At what discount rate will this project break even?	20%
c.	Should the firm purchase the new equipment?	Yes. Firm should purchase new equipment considering the additional cash flow generated and positive NPV