Custom Search

Proper Cash Flows

Cash Flows. A new project will generate sales of $74 million, costs of $42 million, and depreciation expense of $10 million in the coming year. The firm`s tax rate is 35 percent. Calculate cash flow for the year using all three methods discussed and confirm that they are equal.

2. Cash Flows. Canyon Tours showed the following components of working capital last year:

a. What was the change in net working capital during the year?

b. If sales were $36,000 and costs were $24,000, what was cash flow for the year? Ignore taxes.

3. Cash Flows. Tubby Toys estimates that its new line of rubber ducks will generate sales of $7 million, operating costs of $4 million, and a depreciation expense of $1 million. If the tax rate is 40 percent, what is the firm`s operating cash flow? Show that you get the same answer using all three methods to calculate operating cash flow.

4. Cash Flows. We`ve emphasized that the firm should pay attention only to cash flows when assessing the net present value of proposed projects. Depreciation is a noncash expense. Why then does it matter whether we assume straight-line or MACRS depreciation when we assess project NPV?

5. Proper Cash Flows. Quick Computing currently sells 10 million computer chips each year at a price of $20 per chip. It is about to introduce a new chip, and it forecasts annual sales of 12 million of these improved chips at a price of $25 each. However, demand for the old chip will decrease, and sales of the old chip are expected to fall to 3 million per year. The old chip costs $6 each to manufacture, and the new ones will cost $8 each. What is the proper cash flow to use to evaluate the present value of the introduction of the new chip?

6. Calculating Net Income. The owner of a bicycle repair shop forecasts revenues of $160,000 a year. Variable costs will be $45,000, and rental costs for the shop are $35,000 a year. Depreciation on the repair tools will be $10,000. Prepare an income statement for the shop based on these estimates. The tax rate is 35 percent.

7. Cash Flows. Calculate the operating cash flow for the repair shop in the previous problem using all three methods suggested in the material: (a) net income plus depreciation; (b) cash inflow/cash outflow analysis; and (c) the depreciation tax shield approach. Confirm that all three approaches result in the same value for cash flow.

8. Cash Flows and Working Capital. A house painting business had revenues of $16,000 and expenses of $9,000. There were no depreciation expenses. However, the business reported the following changes in various components of working capital: Calculate net cash flow for the business for this period.

9. Incremental Cash Flows. A corporation donates a valuable painting from its private collection to an art museum. Which of the following are incremental cash flows associated with the donation?

a. The price the firm paid for the painting.

b. The current market value of the painting.

c. The deduction from income that it declares for its charitable gift.

d. The reduction in taxes due to its declared tax deduction.

10. Operating Cash Flows. Laurel`s Lawn Care, Ltd., has a new mower line that can generate revenues of $120,000 per year. Direct production costs are $40,000 and the fixed costs of maintaining the lawn mower factory are $15,000 a year. The factory originally cost $1 million and is being depreciated for tax purposes over 25 years using straight-line depreciation. Calculate the operating cash flows of the project if the firm`s tax bracket is 35 percent.

Operating Cash Flows. Talia`s Tutus bought a new sewing machine for $40,000 that will be depreciated using the MACRS depreciation schedule for a 5-year recovery period.

a. Find the depreciation charge each year.

b. If the sewing machine is sold after 3 years for $20,000, what will be the after-tax proceeds on the sale if the firm`s tax bracket is 35 percent?

12. Proper Cash Flows. Conference Services Inc. has leased a large office building for $4 million per year. The building is larger than the company needs: two of the building`s eight stories are almost empty. A manager wants to expand one of her projects, but this will require using one of the empty floors. In calculating the net present value of the proposed expansion, upper management allocates one-eighth of $4 million of building rental costs (i.e., $.5 million) to the project expansion, reasoning that the project will use one-eighth of the building`s capacity.

a. Is this a reasonable procedure for purposes of calculating NPV?

b. Can you suggest a better way to assess a cost of the office space used by the project?

13. Cash Flows and Working Capital. A firm had net income last year of $1.2 million. Its depreciation expenses were $.5 million, and its total cash flow was $1.2 million. What happened to net working capital during the year?

14. Cash Flows and Working Capital. The only capital investment required for a small project is investment in inventory. Profits this year were $10,000, and inventory increased from $4,000 to $5,000. What was the cash flow from the project?

15. Cash Flows and Working Capital. A firm`s balance sheets for year-end 2000 and 2001 contain the following data. What happened to investment in net working capital during 2001? All items are in millions of dollars.