Corporate Finance Ross Mini Case 8Ed

Topics: Weighted average cost of capital, Investment, Market value Pages: 22 (2562 words) Published: April 24, 2014


CHAPTER 10
MINOR INTERNATIONAL
PART 1

a. The software consultant is a sunk cost. The consultant is being hired to assist with the decision as to whether to invest in either project or not. This cost will be incurred before the decision for either project is made and is not incremental to either project. Consequently, it is considered a sunk cost.

In addition, the inter-company charge for the computer time is not an incremental cash flow to the firm. Consequently, it is really an internal allocation and should not be considered in the valuation of either project.

Alternative A calculations:

Initial
0
1
2
3
4
5
Investment
-185,000

Cost savings

82,000
82,000
64,000
53,000
37,000

Tax @ 35%

28,700
28,700
22,400
18,550
12,950

After tax savings

53,300
53,300
41,600
34,450
24,050

PV @ 15%
-185,000
46,347.83
40,302.46
27,352.68
19,696.90
11,957.10

Tax rate
k rate
CCA rate
Cost
Salvage

35.00%
15.00%
30.00%
$185,000
$0

PVCCATS =
40,351.45

NPV =
$1,008.42

Assuming that assets will remain in this class at the end of the project and continue to be claimed for CCA purposes, the PVCCATS is equal to:

Also, we assume that there are no working capital investments required or salvage values at the end of the project. The NPV is found from adding up the initial cost, the PV of after tax cash flows and the PVCCATS:

NPV = -185,000 + 46,347.83 + 40,302.46+ 27,352.68+ 19,696.90+ 11,957.10+ 40,351.45= $1,008.42

Therefore, Alternative A has a positive NPV of $1,008.42

Alternative B calculations:

Initial
0
1
2
3
4
5
Investment
-320,000

Cost savings

112,000
124,000
101,000
93,000
56,000

Tax @ 35%

39,200
43,400
35,350
32,550
19,600

After tax savings

72,800
80,600
65,650
60,450
36,400

PV @ 15%
-320,000
63,304.35
60,945.18
43,165.94
34,562.48
18,907.23

Tax rate
k rate
CCA rate
Cost
Salvage

35.00%
15.00%
30.00%
$320,000
$0

PVCCATS =
69,797.10

NPV = -
$30,127.72

Assuming that assets will remain in this class at the end of the project and continue to be claimed for CCA purposes, the PVCCATS is equal to:

Also, we assume that there are no working capital investments required or salvage values at the end of the project.

NPV = -320,000 + 63,304.35+ 60,945.18+ 43,165.94+ 34,562.48+ 18,907.23+ 69,797.10
= -$30,127.72

Alternative B has a NPV of -$30,127.72.

Since Alternative A is the only project with a positive NPV, Alternative A should be recommended.

b. With three years of cash flows only, the NPV for each project would be as follows:

Alternative A:

NPV = -185,000 + 46,347.83 + 40,302.46 + 27,352.68 + 40,351.45 = $30,645.58 Alternative B:

NPV = -320,000 + 63,304.35 + 60,945.18 + 43,165.94 + 69,797.10 = -$82,787.43

Again, since Alternative A is the only project with a positive NPV, Alternative A should be recommended.

c. The NPV for Alternative B is large and negative. The addition of salvage value at the levels indicated will not change this fact. Consequently, only the NPV for Alternative A has been calculated based on salvage at the end of years 3, 4 and 5 as follows:

Year 3
Year 4
Year 5
After- tax salvage value
$50,000
$35,000
$0
PV of salvage
32,875
20,011.36

NPV before salvage
As in part b)
-30,645.58
See Note ** below
-15,948.68
As in part a)
1,008.42
Total NPV including salvage

2,230.23

4,062.68

1,008.42

** NPV before salvage after 4 years =
= -185,000 + 46,347.83 + 40,302.46 + 22,352.68 + 19,696.90 + 40,351.45 = $-15,948.68

Based on the above calculations, the company’s best alternative, with the...
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