Vallejo Cablevision Company provides television cable service to two counties in Southern California. The firm’s management is considering the construction of a new satellite dish in December of 20x0. The new antenna would improve reception and the service provided to customers. The dish antenna and associated equipment will cost $200,000 to purchase and install. The company’s old equipment, which is fully depreciated, can be sold now for $20,000. The company president expects the firm’s improved capabilities to result in additional revenue of $80,000 per year during the dish’s useful life of seven years. The incremental operating expenses associated with the new equipment are projected to be $10,000 per year. These incremental revenues and expenses are in real dollars.
The new satellite dish will be depreciated under the MACRS depreciation schedule for the 5-year property class. The company’s tax rate is 40 percent.
Vallejo Cablevision’s president expects the real rate of interest in the economy to remain stable at 10 percent. She expects the inflation rate, currently running at 20 percent, to remain unchanged.
1. Prepare a schedule of cash flows projected over the next eight years (20x0 through 20x7), measured in nominal dollars. The schedule should include the initial costs of purchase and installation, the after-tax incremental revenue and expenses, and the depreciation tax shield. Remember to express the incremental revenues and expenses in nominal dollars.
2. Compute the nominal interest rate.
3. Prepare a net-present-value analysis of the proposed new satellite dish. Use cash flows measured in nominal dollars and a nominal discount rate equal to the nominal interest rate.