MGMT 610 – Financial Management Professor Boquist Homework #3 – 50 Points Total **Due by 11:59PM on due date Reminder: upload your file on Brightspace. Please use the spreadsheet I posted...

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MGMT 610 – Financial Management
Professor Boquist
Homework #3 – 50 Points Total
**Due by 11:59PM on due date
Reminder: upload your file on Brightspace. Please use the spreadsheet I posted (“HW3_template.xlsx”)
to complete your homework. You may consult classmates, but each student is required to submit their
own file.
Question 1
Find the NPV, IRR, and Discounted Payback for the following project:
• Cost of project = $5,000,000.
• Project generates an after-tax cash flow of $2,000,000 per year for 9 years.
• Discount rate of 12%.
Question 2
One of your best friends from childhood, Hermione, is an entrepreneur that opened a pizza restaurant
(called The Crusty Crookshanks) five years ago. It has been a huge success, and she is currently
considering investing to expand her operations. The property next door to her restaurant is for sale, so she
is evaluating whether she should purchase that property, which would greatly expand the seating capacity,
as well as allowing her to double the kitchen space, so she’d be able to cook many more pizzas daily (in
the past few months she’s had trouble keeping up with demand).
Hermione has hired you to help her with the financial analysis of this potential expansion project.
As you’re putting your 10-year projections together, you estimate the following:
• The up-front cost of the new building, construction, and kitchen remodeling will be $5,550,000,
and will take approximately one year. You estimate this can be depreciated over the first 5 years,
using the following accelerated annual depreciation schedule: 35%, 30%, 20%, 10%, and 5%.
• Year 1 will have a sales reduction of $850,000 relative to not doing the expansion.
• Years 2 through 10 will have an increase in sales of $900,000 in year 2, growing by 8% per year.
• Costs will increase by $25,000 in year 2, growing by 5% per year.
• NWC investment of $350,000 today (recovered at the end).
• Salvage value of $1,750,000 at the end.
• Tax rate of 29%.
• The appropriate discount rate is 14%.
Using your assumptions, find the NPV of the restaurant expansion. What is your recommendation to
Hermione
Answered 10 days AfterSep 09, 2022

Answer To: MGMT 610 – Financial Management Professor Boquist Homework #3 – 50 Points Total **Due by 11:59PM on...

Hari Kiran answered on Sep 19 2022
60 Votes
Introduction
        Types of Cash Flows of a Project
        (i) Initial Investment or Cash Flows
        these include the After tax Capital Expenditure and Incremental Net Working Capital incurred at the beginning of the project.
        (a) Capital Expenditure includes:
         - Orignial Cost of New Assets, installation
expenses and Freight.
         - Cost of Ancillary services and Equipments.
         - Preliminary Expenses like Brokerage, Commission, Legal Charges Etc.
         - Other Incidental Expenses like cost of delay in procurement, installation, Etc.
        In case of Replacement, salvage value (after tax) realised from the old asset is deducted from the Initial Investment.
        We should ignore Sunk Costs. these are the costs already incurred prior to beginning of the project and are not recoverable. Sunk Costs are irrelevant for the future and hence should not be included in the Initial Cash Flows.
        (b) Incremental Net Working Capital
        Apart from Capital expenditure, a Project also brings about an increase in the use of Working Capital like increase in Debtors for Sales, increase in Creditors for Purchases, Cash requirement for day to day Project Expenditure Etc.
        Initial Cash Flow = + Cost of New Assets and Ancillary services and + Installation Cost + Other Incidental Expenses
                 - Salvage Value of Old Asset +/- tax Benefit / Liability on account of Profit or Loss on Sale of Old Asset
                 + Incremental Net Working Capital
        (a) Operating Cash Inflows
        these represent the net figure of operating cash expenses and incomes arising due to the project.
        these cash flows may be constant or may vary throughout the life of the project.
        Operating Cash Flows are calculated by adding Non-Cash Expenses and Finance Charge net of tax to the Profit after tax from the project.
        Operating Cash Inflows = Earnings Before interest and tax (1- tax rate) + Depreciation
        (c) Changes in Working Capital
        Increase in Working Capital will be considered as Cash Outflow and decrease in Working Capital will be considered as Cash Inflow.
        these cash outflows and cash inflows are adjusted to profit to get cash inflows.
        Subsequent Cash Flows = Profit After tax + Depreciation + Finance Charge (1-tax)
                 - Subsequent Capital Expenditure and Periodic repairs
                 +/- Decrease / Increase in Working Capital
                 +/- Subsequent Cash Inflows / Outflows
        (iii) Terminal Cash Inflows
        These represent the last year's Cash Inflow at the end of the Economic life of the project.
        Terminal Cash Inflows includes:
        (a) Operating Cash inflows
        this is the Annual Cash Inflow for the last year of the project life.
        (b) After tax Salvage Value of the Project
        At the end of Project life all assets related to it are sold off at Market Price. If the assets are sold at Profit, tax Liability arises; otherwise, tax Benefit.
         (c) Working Capital Released
        Net working capital invested in the project, is released at its book value at the end of the project which forms a part of terminal...
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