Animation Nation (AN) copies and distributes Japanese animated videos for the U.S. market. In order to better serve this market, it is considering the immediate purchase of new video reproduction equipment costing $300,000. AN expects this equipment to last 3 years and plans to use straight-line depreciation during its economic life. At the end of three years it will place the equipment at the street curb, from which it will costlessly disappear. The new equipment is expected to generate sales of $500,000 in the first year, $350,000 in the second year, and $100,000 in the third year. The shrinkage in sales is expected to result from new entries into the market. In order to support these sales AN will require $50,000 in net working capital (NWC) in the first year, keeping it at that level until the third year, at which time NWC will be drawn down to zero, the level it was at before the project was undertaken. The costs of goods sold are expected to be $200,000 in the first year, $210,000 in the second year and $80,000 in the third year. The tax rate applicable to AN’s situation is 34%; of course, if EBIT is negative, it will pay no tax.

1. Develop a Depreciation Schedule.

Time	0	1	2	3
Depreciation

2. Estimate NWC and NFA. This can be thought of as a pro forma balance sheet.

Time	0	1	2	3
NWC
NFA

3. Compute ΔNWC and NCS.

Time	0	1	2	3
Change in NWC
NCS

4. Estimate OCF. Recall that OCF = EBIT + Depreciation – Taxes. This requires the development of what can be thought of as pro forma income statements for years 0, 1, 2 and 3. Each statement should be of the general form

Year	0	1	2	3
Investments
COGS
Depreciation
EBIT
Taxes @34
NI
OCF

5. Compute CF. Recall that CF = OCF - NWC – NCS, where OCF is operating cash flow, CF is cash flow, NWC is change in net working capital, and NCS is net capital spending. Given this information, complete the table below. Time 0 1 2 3 OCF ∆NWC NCS CF

Year	0	1	2	3
OCF
Change in NWC
NCS
CF

6. Determine the required return. By assumption, it is 15%.

7. Compute NPV.

8. Reflect and decide. Should Animation Nation undertake this project?

9. Compute IRR and decide should Animation Nation undertake the project based on IRR.

Answer rating: 100% (QA)

1 Company follows straight line depreciation Depreciation for each year Capital Spending at start li... View the full answer