Henke Malfoy, CFA, is an analyst with a major manufacturing firm. Currently, he is evaluating the replacement of some production equipment. The old machine is still functional and could continue to serve in its current capacity for three more years. If the new equipment is purchased, the old equipment (which is fully depreciated) can be sold for $50,000 now but will be worthless in three years. The new equipment will cost $400,000, including shipping and installation. If the new equipment is purchased, the company's revenues will increase by $175,000 and costs by $25,000 for each year of the equipment's 3-year life. There is no expected change in net working capital. The new machine will be depreciated using a 3-year MACRS schedule (note: the 3-year MACRS schedule is 33.0% in the first year, 45% in the second year, 15% in the third year, and 7% in the fourth year). At the end of the life of the new equipment (i.e., in three years), Malfoy expects that it can be sold for $10,000. The firm has a marginal tax rate of 40%, and the cost of capital on this project is 20%. In calculation of tax liabilities, Malfoy assumes that the firm is profitable, so any losses on this project can be offset against profits elsewhere in the firm. Malfoy calculates a project NPV of -$62,574.

 1. The initial outlay for the project is closest to: CBA

 A. $350,000.

B. $370,000.

C. $400,000. 

2. The after-tax operating cash flow for the first year of operations with the new equipment (excluding the initial outlay) is closest to: CBA

 A. $10,800.

B. $132,000.

C. $142,800. 

3. What is the effect of taxes on the operating cash flow in year 2? CBA

 A. Decrease by $7,200.

B. Increase by $7,200.

C. Increase by $12,000. 

4. The combined after-tax operating cash flow and terminal year after-tax nonoperating cash flow in year 3 is closest to: CBA

 A. $131,200.

B. $151,200.

C. $152,200. 

5. Suppose for this question only that Malfoy has forgotten to reflect a decrease in inventory that will result at the beginning of the project. The most likely effect on estimated project NPV of this error: CBA

A. is to overestimate NPV.

B. is to underestimate NPV.

C. depends on whether the inventory is assumed to build back up to its previous level at the end of the project or the decrease in inventory is permanent.

6. What is the IRR based on Malfoy's NPV estimate, and should the project be accepted or rejected in order to maximize shareholder value? CBA

     IRR          Project

A. 8.8%         Accept

B. 8.8%         Reject

C. 21.5%       Accept

Answer rating: 100% (QA)

The detailed answer for the above question is provided below Question 1 The initial outlay for the p... View the full answer