Financial Management Essay

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Ch 12-1 Tuesday, April 17, 2007 Soln. 1. Truman industries is considering an expansion. The necessary equipment would be purchased for $9 million, and it would also an additional $3 million investment in working capital. The tax rate is 40 percent. a. what is the initial investment outlay? b. The company spent and expensed $50,000 on research related to the project last year. Would this change your answer? Explain. c. The company plans to use a building it owns but is not now using to house the project. The building could be sold for $ 1 million after taxes and real estate commissions. How could that affect your answer? a. Equipment $ 9,000,000 NOWC Investment 3,000,000 Initial investment outlay $12,000,000 b. No, last year’s $50,000 expenditure is considered a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis. c. The potential sale of the building represents an opportunity cost of conducting the project in that building. Therefore, the possible after-tax sale price must be charged against the project as a cost. 2. Eisenhower communications is trying to estimate the first-year net operating cash flow (at year 1) for a proposed project. The financial staff has collected the following information on the project: Sales revenue $10 million Operating costs (excluding depreciation) $ 7 million Depreciation $ 2 million Interest expense $ 2 million The company has a 40 percent tax rate, and its WACC is 10 percent a. What is the project’s operating cash flow for the first year? b. If this project would cannibalize other projects by $1 million of cash flow before taxes per year. How would this change your answer to part a? c. Ignore part b. if the TR dropped to 30%, how would that change your answer to part a? a. [pic] b. b. The cannibalization of

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