5CF – Lecture 6 Questions

1. Consider the following income statement:

Fill in the missing numbers and then calculate the OCF. What is the depreciation tax shield?

2. A proposed new project has projected sales of NKr108,000, costs of NKr51,000, and
depreciation of NKr6,800. The tax rate is 35 per cent. Calculate operating cash flow using the
four different approaches described in the chapter, and verify that the answer is the same in
each case.

3. Summer Tyme plc is considering a new three-year expansion project that requires an initial
non-current asset investment of £3.9 million. The non-current asset will be depreciated using
the 20 per cent reducing-balance method. At the end of three years it will be worthless. The
project is estimated to generate £2,650,000 in annual sales, with costs of £840,000. If the tax
rate is 28 per cent, what is the OCF for each year of this project?

4. A five-year project has an initial fixed non-current asset investment of £270,000, an initial
NWC investment of £25,000, and an annual OCF -£42,000. The non-current asset is
depreciated 20 per cent reducing-balance over the life of the project, and has no salvage
value. If the required return is 11 per cent, what is this project’s equivalent annual cost, or
EAC? Ignore taxation.

5. Compact fluorescent lamps (CFLs) have become more popular in recent years, but do they
make financial sense? Suppose a typical 60 watt incandescent light bulb costs £0.50 and
lasts 1,000 hours. A 15 watt CFL, which provides the same light, costs £3.50 and lasts for
12,000 hours. A kilowatt-hour of electricity costs £0.101. A kilowatt-hour is 1,000 watts for 1
hour. If you require a 10 per cent return and use a light fixture for 500 hours per year, what is
the equivalent annual cost of each light bulb?

6. Aguilera Acoustics (AA) projects unit sales for a new seven-octave voice emulation implant
as follows:

Production of the implants will require €1,500,000 in net working capital in year 0. For year 1
onwards it will require net working capital investments each year equal to 15 per cent of the
projected sales for the following year. Total fixed costs are €900,000 per year, variable production
costs are €240 per unit, and the units are priced at €325 each. The equipment needed to begin
production has an installed cost of €21,000,000. Because the implants are intended for professional
singers, this equipment is considered industrial machinery, and is thus depreciated by the reducing-
balance method at 20 per cent per annum. In five years this equipment can be sold for 20 per cent of
its acquisition cost. AA is in the 35 per cent marginal tax bracket, and has a required return on all its
projects of 18 per cent. Based on these project estimates, what is the NPV of the project? What is
the IRR? (Try 11% and 16%)