Essentials Of Investments
11th Edition
ISBN: 9781260013924
Author: Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher: Mcgraw-hill Education,
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After spending $9,600 on client-development, you have just been offered a big production contract by a new client. The contract will add $196,000 to your revenues for each of the next five years and it will cost you $96,000 per year to make the additional product. You will have to use some existing equipment and buy new equipment as well. The existing equipment is fully depreciated, but could be sold for $45,000 now. If you use it in the project, it will be worthless at the end of the project. You will buy new equipment valued at $29,000 and use the 5-year MACRS schedule to
$38,000 per year to help with the expansion. You will have to immediately increase your inventory from $20,000 to $30,000. It will return to $20,000 at the end of the project is 21% and your discount rate is 14.7%. What is the
Transcribed Image Text:The form presented is designed for calculating free cash flows for a project over a six-year period, segmented into two parts: years 0 through 2, and years 3 through 6. Each year has its own column where data can be entered, with a series of specific financial metrics listed row by row. These are the steps outlined in each part:
### Calculate the Free Cash Flows for Years 0 through 2
#### Year 0, Year 1, Year 2:
- **Sales:** Enter total sales revenue for each year.
- **Cost of Goods Sold:** Deduct the costs directly associated with the production of the goods sold by the company.
**Gross Profit:** This is calculated as Sales minus Cost of Goods Sold.
- **Annual Cost:** Deduct any other operational costs incurred annually.
- **Depreciation:** Deduct the annual depreciation expense.
**EBIT (Earnings Before Interest and Taxes):** Determine by subtracting Annual Cost and Depreciation from Gross Profit.
- **Tax:** Deduct taxes applicable on EBIT.
**Incremental Earnings:** Calculate earnings after tax.
- **+ Depreciation:** Add back the depreciation expense, as it is a non-cash charge.
- **- Incremental Working Capital:** Deduct any additional working capital needed.
- **- Opportunity Cost:** Deduct opportunity costs, if applicable.
- **- Capital Investment:** Deduct capital invested in the project for each year.
**Incremental Free Cash Flow:** Calculate by summing Incremental Earnings and Depreciation, then subtracting Working Capital, Opportunity Cost, and Capital Investment.
### Calculate the Free Cash Flows for Years 3 through 6
#### Year 3, Year 4, Year 5, Year 6:
The same steps and calculations are repeated for each of these years, entering the appropriate figures for each financial metric.
### Net Present Value (NPV) Calculation
Finally, the document provides a field to calculate the Net Present Value (NPV) of the project, with a note to round the value to the nearest dollar. This involves discounting the Incremental Free Cash Flows back to their present value and summing them to evaluate the profitability of the project.
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