Fi 515 Week 3 Homework

Week 4

Capital Budgeting Problem

George and William Phelps are considering a 6 year project that would require a cash outlay

of $80,000 for equipment and an additional $20,000 for working capital that would be released

at the end of the project. The equipment would be depreciated evenly over the 6 years and

have a salvage value of $8,000 at the end of 6 years. The project would generate before tax

annual cash inflows of $28,500. The tax rate is 35% and the company’s discount rate is 14%.

Cost of new equipment $80,000.00

Increase need for Working Capital $20,000.00

Length of project 6 years

Salvage Value of equipment at end of project $8,000.00

Annual cash savings if equipment is purchased $28,500.00

Tax Rate 35%

Discount Rate 14%

Depreciation Expense=(cost of equipment-salvage value)/life of equipment

($80,000-$8,000)/6

$12,000.00

Required:

1. What is the annual accounting income?

Annual cash savings $28,500.00

Less: annual depreciation $12,000.00

Before tax income $16,500.00

Income taxes (35%) $5,775.00

Annual accounting net income $10,725.00

2. What is the annual after tax cash flow?

Annual accounting net income $10,725.00

Add back non-cash depreciation $12,000.00

Annual after tax net cash inflows $22,725.00

3. What is the payback based upon the initial cash outflow?

Payback period = Cost of initial cash outflows (investment) / annual cash inflows

($80,000+$20,000) / $22,725

4.40 years

4. What is the discounted payback based upon the initial cash outflows?

Annual Cash Inflows 14% PV Factor Discounted Cash Flow Balance of Initial Inv Discounted Payback

Year 0 $100,000.00...