Problems and Solutions
Chapter 10
3.
Find the operating cash flow for the year for Spacely Sprockets if they had sales revenue of $300,000,000, cost of goods sold of $140,000,000, sales and administrative costs of $40,000,000, depreciation expense of $65,000,000 and a tax rate of 40%.
Solution: Using income statement format we have,
Sales $300,000,000
COGS $140,000,000
SG&A
Depreciation
EBIT
Taxes (@ 40%)
$ 40,000,000
$ 65,000,000
$55,000,000
$22,000,000
Net Income $33,000,000
Operating Cash Flow = EBIT + Depreciation – Taxes
Operating Cash Flow = $55,000,000 + $65,000,000 - $22,000,000 = $98,000,000
4.
Find the operating cash flow for the year for Cogswell Cogs if they had sales revenue of $80,000,000, cost of goods sold of $35,000,000, sales and administrative costs of
$6,400,000, depreciation expense of $7,600,000 and a tax rate of 30%.
Solution: Using income statement format we have,
Sales $80,000,000
COGS
SG&A
Depreciation
$35,000,000
$ 6,400,000
$ 7,600,000
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EBIT
Taxes (@ 30%)
$31,000,000
$ 9,300,000
Net Income $33,000,000
Operating Cash Flow = EBIT + Depreciation – Taxes
Operating Cash Flow = $31,000,000 + $7,600,000 - $9,300,000 = $14,100,000
11.
Erosion Costs – Fat Tire Bicycle Company currently sells 40,000 bicycles per year.
The current bike is a standard balloon tire bike, selling for $90.00 with a production and shipping cost of $35.00. The company is thinking of introducing an off-road bike with a projected selling price of $410 and a production and shipping cost of $360.
The projected market is for 12,000 bikes in annual sales. However, they will loose sales in the fat tire bikes of 8,000 per year if they introduce the new bike. What is the erosion cost from the new bike? Should they start producing the off-road bike?
Solution:
Erosion Cost = ($90 - $35) x 8,000 = $520,000
Net Annual Cash Flow with one bike: ($90 - $35) x 40,000 = $2,600,000
Net Annual Cash Flow with two bikes:
($90 - $35) x (40,000 - 8,000) = $2,080,000
($410 - $360) x 12,000 = $600,000
Net Annual CF = $2,080,000 + $600,000 = $2,680,000
Increase of $80,000 per year so add new off-road bike to production.
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15.
Depreciation Expense –Brock Florist Company buys a new delivery truck for
$29,000. It is classified as a light duty truck. b.
Calculate the depreciation schedule using a five year life and MACRS depreciation.
Solution b.
Depreciation schedule using MACRS;
Year One Depreciation = $29,000 x 0.2000 = $5,800
Year Two Depreciation = $29,000 x 0.3200 = $9,280
Year Three Depreciation = $29,000 x 0.1920 = $5,568
Year Four Depreciation = $29,000 x 0.1152 = $3,340.80
Year Five Depreciation = $29,000 x 0.1152 = $3,340.80
Year Six Depreciation = $29,000 x 0.0576 = $1,670.40
16.
Depreciation Expense -- Stan’s Lawn and Tree Company just purchased a new aerial tree trimmer for $91,000. Calculate the depreciation schedule using the useful life category of a single purpose agricultural equipment with MACRS using the half year convention. Assume a 40% tax rate for Stan’s Lawn and Tree Company. What do you notice about the difference in these two methods?
Solution
Depreciation schedule using MACRS;
Year One Depreciation = $91,000 x 0.1429 = $13,003.90
Year Two Depreciation = $91,000 x 0.2449 = $22,285.90
Year Three Depreciation = $91,000 x 0.1749 = $15,915.90
Year Four Depreciation = $91,000 x 0.1249 = $11,365.90
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Year Five Depreciation = $91,000 x 0.0893 = $8,126.30
Year Six Depreciation = $91,000 x 0.0893 = $8,126.30
Year Seven Depreciation = $91,000 x 0.0893 = $8,126.30
Year Eight Depreciation = $91,000 x 0.0445 = $4,049.50
17.
Cost Recovery – Brock Florist Company sold their delivery truck in problem #15 after three years of service. If MACRS was used for the depreciation schedule, what is the after tax cash flow from the sale of the truck (continue to use 30% tax rate) if a.
The sale price was $15,000? b.
The sales price was $10,000? c.
The sales price was $5,000?
Solution
The accumulated depreciation after three years using MACRS is $29,000 x (0.20 +
0.32 + 0.192) = $20,648. The basis in the truck is therefore $29,000 - $20,648 = $8,352. a.
If the sales price is $15,000 then the truck had a gain on sale of $15,000
- $8,352 = $6,648 and the tax liability is $6,648 x 0.30 = $1,994.40. The after tax cash flow is $15,000 - $1,994.40 = $13,005.60 b.
If the sales price is $10,000 then the truck had a gain on sale of $10,000
- $8,352 = $1,648 and the tax liability is $1,648 x 0.30 = $494.40. The after tax cash flow is $10,000 - $494.40 = $9,505.60 c.
If the sales price is $5,000 then the truck had a loss on sale of $5,000 -
$8,352 = $3,352 and the tax credit is $3,352 x 0.30 = $1,005.60. The after tax cash flow is $5,000 + $1,005.60 = $6,005.60
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18.
Cost Recovery – Stan sold the tree trimmer in problem #16 after four years of service.
If MACRS was used for the depreciation schedule, what is the after tax cash flow from the sale of the trimmer (continue to use 40% tax rate) if a.
The sale price was $35,000? b.
The sales price was $28,428.40? c.
The sales price was $21,000?
Solution
The accumulated depreciation after four years using MACRS is $91,000 x (0.1429
+ 0.2449 + 0.1749+ 0.1249) = $62,571.60. The basis in the trimmer is therefore $91,000 -
$62,571.60 = $28,428.40. a.
If the sales price is $35,000 then the trimmer had a gain on sale of $35,000
- $28,428.40 = $6,571.60 and the tax liability is $6,571.60 x 0.40 = $2,628.64.
The after tax cash flow is $35,000 - $2,628.64 = $32,371.36 b.
If the sales price is $28,428.40 then the truck had neither a gain nor loss on sale. There is no tax liability or tax credit on disposal so the after tax cash flow is $28,428.40 c.
If the sales price is $21,000 then the truck had a loss on sale of $21,000 -
$28,428.40 = $7,428.40 and the tax credit is $7,428.40 x 0.40 = $2,971.36. The after tax cash flow is $21,000 + $2,971.36 = $23,971.36
19.
Project Cash Flows & NPV – The managers of Classic Autos Incorporated plan to manufacture classic T-Birds (1957 replicas). The necessary foundry equipment will cost a total of $4,000,000 and will be depreciated using a five-year MACRS life. Projected sales
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in annual units for the next five years are 300 per year . If sales price is $27,000 per car, variable costs are $18,000 per car, and fixed costs are $1,200,000 annually, what are the annual operating cash flows if the tax rate is 30% ? The equipment is sold for salvage for
$500,000 at the end of year five. What is the after tax cash flows of the salvage? Net working capital increases by $600,000 at the beginning of the project (Year 0) and is reduced back to its original level in the final year. What is the incremental cash flows of the project? Using a discount rate of 12% for the project, should the project be accepted or rejected with the NPV decision model?
Solution
Annual depreciation of foundry equipment is:
Year One, $4,000,000 x 0.20 = $800,000
Year Two, $4,000,000 x 0.32 = $1,280,000
Year Three, $4,000,000 x 0.192 = $768,000
Year Four, $4,000,000 x 0.1152 = $460,800
Year Five, $4,000,000 x 0.1152 = $460,800
Operating Cash Flows are:
Annual Sales, 300 x $27,000 = $8,100,000
Annual COGS, 300 x $18,000 = $5,400,000
Sales Revenue
- COGS
- Fixed Costs
- Depreciation
In thousands (rounded)
Year 1 Year 2 Year 3 Year 4 Year 5
$8,100 $8,100 $8,100 $8,100 $8,100
$5,400 $5,400 $5,400 $5,400 $5,400
$1,200 $1,200 $1,200 $1,200 $1,200
$ 800 $1,280 $ 768 $ 461 $ 461
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EBIT
- Taxes
Net Income
+ Depreciation
$ 700 $ 220 $ 732 $1,039 $1,039
$ 210 $ 66 $ 220 $ 312 $ 312
$ 490 $ 154 $ 512 $ 727 $ 727
Operating Cash Flows
$ 800 $1,280 $ 768 $ 461 $ 461
$1,290 $1,434 $1,280 $1,188 $1,188
The equipment is sold for salvage for $500,000 at the end of year five. It has a book value of $4,000,000 - $800,000 - $1,280,000 - $768,000 - $460,800 - $460,800 = $230,400
Gain on Sale is $500,000 - $230,400 = $269,600
Tax on Gain is $269,600 x 0.30 = $80,880
And after-tax cash flow on disposal is $500,000 - $80,880 = $419,120.
Incremental Cash Flows for Project (Answer in Thousands, $000)
Account/Activity Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Investment -$4,000

NWC -$ 600 $ 600
OCF
Salvage Value
$1,290 $1,434 $1,280 $1,118 $1,118
$ 419
Total Cash Flows -$4,600 $1,290 $1,434 $1,280 $1,118 $2,137
(Incremental)
NPV @ 12% = -$4,600 + $1,290/1.12 + $1,434/1.12
2
+ $1,280/1.12
3
+ $1,118/1.12
4
+
$2,137/1.12
5
= -$4,600 + 1,241 + 1,199 + $911 + $711 + $1,213 = $529
Accept the project because NPV is positive $529,209 (without any rounding).
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