3.5 Capital Budgeting, part 1 - Solutions

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3.5 Capital Budgeting, part 1 - Solutions

University of Texas at Austin
Fin 320f - Foundations of Finance
Foundations of Finance Documents

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FIN 320F Foundations of Finance 3.5 Capital Budgeting, part 1 – Solutions 1. Valiant Corp. purchased new printing equipment for $100,000 to support its expansion into the motivational poster business. Valiant hired a freight company to deliver the equipment, at a cost of $1,500. In addition, they hired some specialists to modify the equipment to suit Valiant’s requirements; this cost $7,000. The sales tax rate is 10%. The equipment is expected to have a depreciable life of 10 years. What is the installed cost (that is, the gross book value) of the new equipment? Installed cost of new asset = Purchase price + Installation charges Installed cost of new asset = $100,000 + 1,500 + $7,000 = $108,500 2. A corporation is considering expanding its operations to meet growing demand. The installed cost of the necessary new equipment will be $500,000. The equipment will be depreciated using straight-line depreciation over its 8-year life to a value of $0, at which point it is expected to be sold for after-tax proceeds of $50,000. The current accounts are expected to change as well. Management expects cash to increase by $20,000, accounts receivable to increase by $40,000, and inventories to increase by $60,000. At the same time, accounts payable will rise by an estimated $50,000 and accrued liabilities are predicted to go up $10,000. Long-term debt (necessary to finance the equipment) will increase by $100,000. a) What is the expected change in net working capital? Current Assets: Cash $20,000 Accounts Receivable 40,000 Inventory 60,000 Total Change $120,000 Current Liabilities: Accounts Payable $50,000 Accruals 10,000 Total Change $60,000 Change in Net Working Capital = Change in Current Assets – Change in Current Liabilities Change in Net Working Capital = $120,000 – $60,000 = $60,000 increase b) What is the total initial investment? When will it occur? Initial Investment = Installed cost of new asset + increase in Net Working Capital Initial Investment = $500,000 + 60,000 = $560,000 The initial investment will occur immediately, at present, at time = 0. c) What is the total terminal cash flow? When will it occur? Reversal of Net Working Capital $60,000 After-tax proceeds from sale of the equipment 50,000 Total terminal cash inflow $110,000 This cash will be received at the end of the project, at the end of year 8. SourceDocument.docx Page 1 of 4

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