Book: Fundamentals ofFinancial

ofFinancial Management,
Management, James C. Van HorneJohn
HorneJohn M. Wachowicz, Jr., 13th
13th Edition, 2008

1. Thoma Pharmaceutical Company may buy DNA-testing equipment costing $60,000. This
equipment is expected to reduce labor costs of the clinical staff by $20,000 annually. The
equipment has a useful life of five years but falls in the three-year property class for cost
recovery (depreciation) purposes. No salvage value is expected at the end. The corporate
tax rate for Thoma (combined federal and state) is 38 percent, and its required rate of
return is 15 percent. (If profits after taxes on the project are negative in any year, the firm This Model is prepared by Rajib Dahal. If you need
will offset the loss against other firm income for that year.) On the basis of this information, excelsheet calculation, please contact me at my email at
what are the relevant cash flows? rajib.dahal@nu.edu.kz/rajib.dahal@gmail.com
Capital Budgeting and Estimating Cash Flows - PART V - Chapter 12, Problems at Page No. 319
Assumptions
Annual reduced labour cost 20,000.00 Depreciation Schedule for three year property class (for tax purpose)
Year 1 33.33%
Capex for new machine 60,000.00 Year 2 44.45%
Year 3 14.81%
Tax Rate 38% Year 4 7.41%
Required rate of return 15%
Discounted Cash Flow Year Year Year Year Year Year
0 1 2 3 4 5
Initial Capex Investment 60,000.00
Cash savings from new machine 20,000.00 20,000.00 20,000.00 20,000.00 20,000.00
D&A(for tax purpose) 19,998.00 26,670.00 8,886.00 4,446.00
Cashflow before taxation 2.00 - 6,670.00 11,114.00 15,554.00 20,000.00
Taxation 0.76 - 2,534.60 4,223.32 5,910.52 7,600.00
Cash flows after taxation 1.24 - 4,135.40 6,890.68 9,643.48 12,400.00
Add: D&A (for tax purpose) 19,998.00 26,670.00 8,886.00 4,446.00 -
Transaction Cash flows 60,000.00 19,999.24 22,534.60 15,776.68 14,089.48 12,400.00

Discount Factor 1.00 0.87 0.76 0.66 0.57 0.50

Discount Cash flow 60,000.00 17,390.64 17,039.40 10,373.42 8,055.71 6,164.99
NPV -975.84

Book: Fundamentals ofFinancial

ofFinancial Management,
Management, James C. Van HorneJohn
HorneJohn M. Wachowicz, Jr., 13th
13th Edition, 2008
2. In Problem 1, suppose that 6 percent inflation in savings from labor costs is expected over
the last four years, so that savings in the first year are $20,000, savings in the second year
are $21,200, and so forth.
a. On the basis of this information, what are the relevant cash flows?
a. On the basis of this information, what are the relevant cash flows?
b. If working capital of $10,000 were required in addition to the cost of the equipment and This Model is prepared by Rajib Dahal. If you need
this additional investment were needed over the life of the project, what would be the excelsheet calculation, please contact me at my email at
effect on the relevant cash flows? (All other things are the same as in Problem 2, Part (a).) rajib.dahal@nu.edu.kz/rajib.dahal@gmail.com
Capital Budgeting and Estimating Cash Flows - PART V - Chapter 12, Problems at Page No. 319
Assumptions
Annual reduced labour cost 20,000.00 Depreciation Schedule for three year property class (for tax purpose)
Annual Growth rate in savings 6% Year 1 33.33%
Capex for new machine 60,000.00 Year 2 44.45%
Year 3 14.81%
Tax Rate 38% Year 4 7.41%
Required rate of return 15%
Discounted Cash Flow Year Year Year Year Year Year
0 1 2 3 4 5
Initial Capex Investment 60,000.00
Cash savings from new machine 20,000.00 21,200.00 22,472.00 23,820.32 25,249.54
D&A(for tax purpose) 19,998.00 26,670.00 8,886.00 4,446.00
Cashflow before taxation 2.00 -5470.00 13,586.00 19,374.32 25,249.54
Taxation 0.76 -2078.60 5,162.68 7,362.24 9,594.82
Cash flows after taxation 1.24 -3391.40 8,423.32 12,012.08 15,654.71
Add: D&A (for tax purpose) 19,998.00 26,670.00 8,886.00 4,446.00 -
Transaction Cash flows 60,000.00 19,999.24 23,278.60 17,309.32 16,458.08 15,654.71

Discount Factor 1.00 0.87 0.76 0.66 0.57 0.50

Discount Cash flow 60,000.00 17,390.64 17,601.97 11,381.16 9,409.96 7,783.16
NPV (for part a. when there is a 6% annual
growth in savings) 3566.89

b. when working capital of $10,000 required over the life of the project
(Note: Since the problem says, "working capital of $10,000 were required in addition to
the cost of the equipment and this additional investment were needed over the life of
the project", which signifies $10,000 will spent in the year 0 (in addition to the cost of
the equipment) and this will be recovered in year 5, thus it becomes over the life of the
project.

Assumptions
Annual reduced labour cost 20,000.00 Depreciation Schedule for three year property class (for tax purpose)
Annual Growth rate in savings 6% Year 1 33.33%
Capex for new machine 60,000.00 Year 2 44.45%
Working Capital requirement 10,000.00 Year 3 14.81%
Tax Rate 38% Year 4 7.41%
Required rate of return 15%
Discounted Cash Flow Year Year Year Year Year Year
0 1 2 3 4 5
Initial Capex Investment 60,000.00
Cash savings from new machine 20,000.00 21,200.00 22,472.00 23,820.32 25,249.54
D&A(for tax purpose) 19,998.00 26,670.00 8,886.00 4,446.00
Cashflow before taxation 2.00 -5470.00 13,586.00 19,374.32 25,249.54
Taxation 0.76 -2078.60 5,162.68 7,362.24 9,594.82
Cash flows after taxation 1.24 -3391.40 8,423.32 12,012.08 15,654.71
Add: D&A (for tax purpose) 19,998.00 26,670.00 8,886.00 4,446.00 -
Change in Net Working Capital 10,000.00 10,000.00
Transaction Cash flows 70,000.00 19,999.24 23,278.60 17,309.32 16,458.08 25,654.71

Discount Factor 1.00 0.87 0.76 0.66 0.57 0.50

Discount Cash flow 70,000.00 17,390.64 17,601.97 11,381.16 9,409.96 12,754.93
NPV (for part a. when there is a 6% annual -1461.34