Question 2 Question 6 Question 3 Question 7 Question 4 Question 8 Copyright 2008 McGraw-Hill/Irwin Copyright 2004 McGraw-Hill/Irwin Capital Budgeting Examples Main Menu Instructions Navigating the Workbook Top CTRL+PAGE DOWN: Moves you to the next sheet in the workbook. Entering your information Top For each question, you will see the following lists and boxes: Student Name: Course Name: Student ID: Course Number: Enter your information in these cells before submitting your work. Entering data Top To enter numbers or text for these questions, click the cell you want, type the data and press ENTER or TAB. Press ENTER to move down the column or TAB to move across the row. For cells or columns where you want to enter text, select Format, and then Cells from Excels main menu at the top of your screen. Select the Number tab and then Text from the category list. Printing Top To print your work, select "File," and then "Print Preview" from Excels main menu at the top of your screen. The print area for each question has been set, but be sure to review the look of your print job. If you need to make any changes, select Setup when you are previewing the document. Help Top There are two sources of help throughout these spreadsheet templates. First, you will find comments in specific cells (highlighted in red) providing tips to what formula or function is needed to complete the problem. Second, you will find links to Microsoft Office's online help page when an Excel Function is needed to complete the problem. keyboard shortcuts: CTRL+PAGE UP: Moves you to the previous sheet in the workbook. at the bottom of the screen. Each worksheet in an Excel workbook will have its own tab. In the spreadsheetsyou will see a separate tab for each problem, along with the Main Menu, Instructions and Help Topics worksheets. Another way to move quickly around an Excel workbook is by using the following You can move quickly around an Excel workbook by selecting the worksheet tab Navigating the Workbook Entering your information Entering data Printing Help These hyperlinks help you move around the workbook quickly. Copyright 2008 McGraw-Hill/Irwin Copyright 2008 McGraw-Hill/Irwin
Question 1: Determining the value of a tax shield Student Name: Course Name: Student ID: Course Number: Select the red highlighted items below for tips and suggestions to complete this problem. Assumptions Installation cost $50,000 Tax rate 35% Opportunity cost 5% MACRS percentages Annual Tax Years Percentages Depreciation Shield 1 20% 2 32% 3 19.2% 4 11.52% 5 11.52% 6 5.76% Value of tax shield if: Installations costs expensed year 1 Value of tax shield if: Capitalized and depreciated FORMULA Copyright 2008 McGraw-Hill/Irwin
Question 2: Analyze capital projects under different tax scenarios Student Name: Course Name: Student ID: Course Number: Select the red highlighted items below for tips and suggestions to complete this problem. Assumptions Projected cash flows: Initial investment ($100,000) Before-tax cash inflow $26,000 Company B tax rate 35% Opportunity cost of capital 8% Year 1 2 3 4 5 6 5-year MACRS Schedule: Company A: Year Projected cash flows 1 2 3 4 5 6 Cash in Tax 0 0 0 0 0 0 Cash flow Company B: Year Projected cash flows 1 2 3 4 5 6 Cash in Depreciation Taxable income Tax Net income Cash flow (a) Calculate project NPV for each company. Company A NPV: FUNCTION Company B NPV: (b) What is the IRR of the after-tax cash flows for each company? What does comparison of the IRRs suggest is the effective corporate tax rate? IRR for A FORMULA IRR for B Effective tax rate 0.0% Help with Excel's NPV function Help with Excel's IRR function Copyright 2008 McGraw-Hill/Irwin
Question 3 Student Name: Course Name: Student ID: Course Number: Click here to use Tables 7.5 and 7.6 for the answer part a. Click here to use Tables CBE.1 and CBE.2 for the answers to parts b and c. c. Continue with the assumed $15 million capital investment and the 11% cost of capital. What if sales, cost of goods sold, and net working capital are each 10% higher in every year? Recalculate NPV. Note: Enter the revised sales, cost, and workingcapital forecasts in the spreadsheet for Table CBE.1. a. How does the guano projects NPV change if IM&C is forced to use the seven-year MACRS tax depreciation schedule? b. New engineering estimates raise the possibility that capital investment will be more than $10 million, perhaps as much as $15 million. On the other hand, you believe that the 20% cost of capital is unrealistically high and that the true cost of capital is about 11%. Is the project still attractive under these alternative assumptions? Copyright 2008 McGraw-Hill/Irwin
Capital Budgeting Exercises Student Name: Course Name: Student ID: Course Number: Select the red highlighted items below for tips and suggestions to complete this problem. a) Read the notes to the table carefully. Which entries make sense? Which do not? Why or why not? Consider each of the items listed and type your answer in the text box below. Attach any additional sheets if necessary. Item Capital Expenditure Research and Development Working Capital Revenues Operating Costs Overhead Depreciation Interest Taxes Net Cash Flow b) What additional information would you need to construct a version of TABLE CBE.7 that makes sense? List the items for which you would like more information below: 1 2 3 4 5 6 7 8 9 10 click here to begin typing Copyright 2008 McGraw-Hill/Irwin c) Construct such a table and recalculate NPV. Make additional assumptions as necessary. Assumptions 1 Enter all figures in thousands of dollars (e.g., $100,000 is entered as 100). 2 3 4 5 6 7 8 9 10 11 12 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 1 2 3 4 5 6 7 8 9 10 11 12 13 Net Cash Flows FORMULA 14 Present value 16 Net present value = FUNCTION Help with Excel's SUM function Copyright 2008 McGraw-Hill/Irwin
Question 5: Using NPV to evaluate a capital project Student Name: Course Name: Student ID: Course Number: Select the red highlighted items below for tips and suggestions to complete this problem. Assumptions Initial investment ($000) Enter all figures in thousands of dollars (e.g., $100,000 is entered as 100). Resale Value year 8 Working Capital Investment Projected working capital (% of Sales) Yearly rental income Rental Income growth rate First year sales Sales growth rate Manufacturing costs (% of Sales) Tax rate Cost of capital Year 1 2 3 4 5 6 7 8 9 Sales Manufacturing Costs Depreciation Earnings before tax Taxes Net Income Working Capital Increase in W.C. Lost After Tax Rental Income FORMULA Initial Investment Sale of Plant Tax on Sale Net Cash Flows FORMULA Present value Net present value = FUNCTION Help with Excel's SUM function Copyright 2008 McGraw-Hill/Irwin
Question 6: Evaluating alternative capital asset decisions Student Name: Course Name: Student ID: Course Number: Select the red highlighted items below for tips and suggestions to complete this problem. The net cash flows for each copier have been calculated for you and are shown below. Select each cell to see the formula used for this calculation. Parts A through D below have been structured to help you develop the solution. Assumptions Current Copier Net Cash Flows: New Copier Projected Net Cash Flows Net * Net * Years Cash Flow Years Cash Flow 1 -675 0 -25,000 2 -675 1 600 3 -4,575 2 1,493 4 -4,889 3 880 5 -5,200 4 443 6 -5,200 5 131 6 131 7 131 * After taxes 8 -261 Cost of capital 7% Income tax rate 35% A. What is the present value of each copier? Present value of current copier Equivalent annual cost $0.00 Present value of new copier B. If you replace the current copier now, when the book value is $6,248 and the resale value is $8,000, what will be the present value of the decision? Present value FORMULA Equivalent annual cost FORMULA C. If you replace the copier in 2 years, when the book value is $2,676 and what will be the present value of the decision? the resale value is $3,500, what will be the present value of the decision? Present value Equivalent annual cost $0 D. If you replace the copier in 6 years, what will be the present value of the decision? Assume a zero book and resale value. Present value FORMULA Equivalent annual cost FORMULA When should the copier be replaced? Help with Excel's PV function Copyright 2008 McGraw-Hill/Irwin
Question 7 Student Name: Course Name: Student ID: Course Number: Select the red highlighted items below for tips and suggestions to complete this problem. 0 1 2 3 4 Cash flows A 40000 10000 10000 10000 PV Cash flows A Cash flows B 50000 8000 8000 8000 8000 PV Cash flows B Annuity Factor - 3 years FUNCTION Annuity Factor - 4 years FUNCTION Equivalent Annual Cost A Equivalent Annual Cost B b. Which machine should Borstal buy? c. How much would you actually have to charge in each future year if there is steady 8% per year inflation? Click here for help with Excel's PV function Copyright 2008 McGraw-Hill/Irwin
Question 8 Student Name: Course Name: Student ID: Course Number: Select the red highlighted items below for tips and suggestions to complete this problem. 0 1 2 3 4 Cash flows A 40000 PV Cash flows A Cash flows B 50000 PV Cash flows B Annuity Factor - 3 years FUNCTION Annuity Factor - 4 years FUNCTION Equivalent Annual Cost A Equivalent Annual Cost B 0 c. How much would you actually have to charge in each future year if there is steady 8% per year inflation? Click here for help with Excel's PV function Copyright 2008 McGraw-Hill/Irwin Period 0 1 2 3 4 5 1. Capital investment 10,000 2. Accumulated depn. 1,583 3,167 4,750 6,333 7,917 3. Year-end book value 10,000 8,417 6,833 5,250 3,667 2,083 4. Working capital 550 1,289 3,261 4,890 3,583 5. Total book value (3 + 4) 8,967 8,122 8,511 8,557 5,666 6. Sales 523 12,887 32,610 48,901 35,834 7. Cost of goods sold 837 7,729 19,552 29,345 21,492 8. Other costs 4,000 2,200 1,210 1,331 1,464 1,611 9. Depreciation 1,583 1,583 1,583 1,583 1,583 10. Pretax profit -4,000 -4,097 2,365 10,144 16,509 11,148 11. Tax -1,400 -1,434 828 3,550 5,778 3,902 12. Profit after tax (10 - 11) -2,600 -2,663 1,537 6,593 10,731 7,246 Notes: No. of years depreciation 6 Assumed salvage value in depreciation calculation 500 Tax rate (percent) 35 TABLE CBE.1 IM&C's guano project -- projections ($ thousands) reflecting inflation and straight line depreciation Main Menu 6 7 -1,949 9,500 0 500 0 2,002 0 2,502 0 19,717 11,830 1,772 1,583 0 4,532 1,449 1,586 507 2,946 942 TABLE CBE.1 IM&C's guano project -- projections ($ thousands) reflecting inflation and straight line depreciation Back to Question Period 0 1 2 3 4 1. Sales 0 523 12,887 32,610 48,901 2. Cost of goods sold 0 837 7,729 19,552 29,345 3. Other costs 4,000 2,200 1,210 1,331 1,464 4. Tax -1,400 -1,434 828 3,550 5,778 5. Cash flow from operations (1 - 2 - 3 - 4) -2,600 -1,080 3,120 8,177 12,314 6. Change in working capital -550 -739 -1,972 -1,629 7. Capital investment and disposal -10,000 0 0 0 0 8. Net cash flow (5 + 6 + 7) -12,600 -1,630 2,381 6,205 10,685 9. Present value -12,600 -1,358 1,654 3,591 5,153 Net present value = 3,520 Cost of capital (percent) 20 TABLE CBE.2 IM&C's guano project -- initial cash flow analysis with straight-line depreciation ($ thousands) Go back to Table 7.1 to change Sales, Cost of goods sold, etc. Main Menu 5 6 7 35,834 19,717 0 21,492 11,830 0 1,611 1,772 0 3,902 1,586 507 8,829 4,529 -507 1,307 1,581 2,002 0 0 1,949 10,136 6,110 3,444 4,074 2,046 961 TABLE CBE.2 IM&C's guano project -- initial cash flow analysis with straight-line depreciation ($ thousands) Back to Question Recovery-Period Years Class 1 2 3 4 5 6 7 8 3-year 33.33 44.45 14.81 7.41 5-year 20.00 32.00 19.20 11.52 11.52 5.76 7-year 14.29 24.49 17.49 12.49 8.93 8.92 8.93 4.45 10-year 10.00 18.00 14.40 11.52 9.22 7.37 6.55 6.55 15-year 5.00 9.50 8.55 7.70 6.93 6.23 5.90 5.90 20-year 3.75 7.22 6.68 6.18 5.71 5.28 4.89 4.52 TABLE CBE.4 Tax Depreciation Schedules by Recovery-Period Class Main Menu 9 10 11 12 13 14 15 16 17 6.56 6.55 3.29 5.90 5.90 5.90 5.90 5.91 5.90 5.91 2.99 4.46 4.46 4.46 4.46 4.46 4.46 4.46 4.46 4.46 TABLE CBE.4 Tax Depreciation Schedules by Recovery-Period Class Back to Question 18 19 20 21 4.46 4.46 4.46 2.23 No. of years depreciation (3, 5 or 7 years only) 5 Tax rate (percent) 35 0 1 2 MACRS % 20.0 32.0 Tax depreciation (MACRS % x depreciable investment) 2,000 3,200 1 Sales 0 523 12,887 2 Cost of goods sold 0 837 7,729 3 Other costs 4,000 2,200 1,210 4 Tax depreciation 0 2,000 3,200 5 Pretax profits -4,000 -4,514 748 6 Tax -1,400 -1,580 262 0 1 2 1. Sales 0 523 12,887 2. Cost of goods sold 0 837 7,729 3. Other costs 4,000 2,200 1,210 4. Tax -1,400 -1,580 262 5. Cash flow from operations (1 - 2 - 3 - 4) -2,600 -934 3,686 6. Change in working capital -550 -739 7. Capital investment & disposal -10,000 0 0 8. Net cash flow (5 + 6 + 7) -12,600 -1,484 2,947 9. Present value -12,600 -1,237 2,047 Net present value = 3,802 Cost of capital (percent) 20 TABLE CBE.5 Tax payments on IM&C's guano project ($ thousands) TABLE CBE.6 IM&C's guano project -- revised cash flow analysis with MACRS depreciation ($ thousands) Note: Vary depreciable life by changing inputs in these tables. Go back to Tables 7.1 or 7.2 to change sales, cost of goods sold, cost of capital etc. Main Menu Period 3 4 5 6 7 19.2 11.5 11.5 5.8 0.0 1,920 1,152 1,152 576 0 32,610 48,901 35,834 19,717 0 19,552 29,345 21,492 11,830 0 1,331 1,464 1,611 1,772 0 1,920 1,152 1,152 576 0 9,807 16,940 11,579 5,539 1,949 3,432 5,929 4,053 1,939 682 Period 3 4 5 6 7 32,610 48,901 35,834 19,717 0 19,552 29,345 21,492 11,830 0 1,331 1,464 1,611 1,772 0 3,432 5,929 4,053 1,939 682 8,295 12,163 8,678 4,176 -682 -1,972 -1,629 1,307 1,581 2,002 0 0 0 0 1,949 6,323 10,534 9,985 5,757 3,269 3,659 5,080 4,013 1,928 912 TABLE CBE.5 Tax payments on IM&C's guano project ($ thousands) TABLE CBE.6 IM&C's guano project -- revised cash flow analysis with MACRS depreciation ($ thousands) Note: Vary depreciable life by changing inputs in these tables. Go back to Tables 7.1 or 7.2 to change sales, cost of goods sold, cost of capital etc. Back to Question
R. M. Edwards and Dorothy Edwards v. Commissioner of Internal Revenue, Loyd W. Disler and Joy Disler v. Commissioner of Internal Revenue, 415 F.2d 578, 10th Cir. (1969)