Concept explainers
Pensacola Cablevision Company provides television cable service to two counties in the Florida panhandle. 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
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.
Pensacola 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.
Required:
- 1. Compute the price index for each year from 20x1 through 20x7, using 1.0000 as the index for 20x0.
- 2. Prepare a schedule of after-tax cash flows measured in real dollars.
- 3. Compute the
net present value of the proposed new satellite dish using cash flows measured in real dollars. Use a real discount rate equal to the real interest rate.
1.
Calculate the price index of new satellite dish for each year.
Explanation of Solution
Cash inflows: The amount of cash received by a company from the operating, investing, and financing activities of the business during a certain period is referred to as cash inflow.
Cash outflows: The amount of cash paid by a company for the operating, investing, and financing activities of the business during a certain period is referred to as cash outflow.
Calculate the price index of new satellite dish for each year as follows:
Year | Price factor | Price factor for each year | Price index |
20x1 | 1.20 | (1.20)1 | 1.2000 |
20x2 | 1.20 | (1.20)2 | 1.4400 |
20x3 | 1.20 | (1.20)3 | 1.7280 |
20x4 | 1.20 | (1.20)4 | 2.0736 |
20x5 | 1.20 | (1.20)5 | 2.4883 |
20x6 | 1.20 | (1.20)6 | 2.9860 |
20x7 | 1.20 | (1.20)7 | 3.5832 |
Table (1)
Note: Normal price rate of 100% is taken as 1 and the inflation rate of 20% is taken as 0.20. Hence, the price factor is 1.20
2.
Prepare a schedule of after tax cash flow measured in real dollars.
Explanation of Solution
Prepare a schedule of after tax cash flow measured in real dollars as follows:
Cash outflow:
Cash inflows:
Schedule for the cash inflows | |||
Year | After tax operating cost savings (2) (F) |
Depreciation expense (1) (G) | After tax cash flow in real dollars |
20x1 | $42,000 | $13,333 | $55,333 |
20x2 | $42,000 | $17,778 | $59,778 |
20x3 | $42,000 | $8,889 | $50,889 |
20x4 | $42,000 | $4,444 | $46,444 |
20x5 | $42,000 | $3,704 | $45,704 |
20x6 | $42,000 | $1,543 | $43,543 |
20x7 | $42,000 | - | $42,000 |
Table (2)
Working note (1):
Calculate the depreciation expense under MACRS.
Depreciation Schedule | ||||||
Year |
MACRS Percentage (A) |
Depreciation |
Tax Rate (C) |
Depreciation expense |
Price index (E) |
Depreciation tax shield in real dollars |
20x1 | 20.00% | $ 40,000 | 40% | $16,000 | 1.2000 | $13,333 |
20x2 | 32.00% | $64,000 | 40% | $25,600 | 1.4400 | $17,778 |
20x3 | 19.20% | $38,400 | 40% | $15,360 | 1.7280 | $8,889 |
20x4 | 11.52% | $23,040 | 40% | $9,216 | 2.0736 | $4,444 |
20x5 | 11.52% | $23,040 | 40% | $9,216 | 2.4883 | $3,704 |
20x6 | 5.67% | $11,520 | 40% | $4,608 | 2.9860 | $1,543 |
20x7 | - | - | - | 3.5832 | - |
Table (3)
Working note (2):
Calculate the after tax incremental cash inflow.
Working note (3):
Calculate the after tax gain on sale of old equipment.
3.
Calculate the net present value of new satellite dish.
Explanation of Solution
Year |
Cash inflow (H) | Present value factor @10% (I) |
Present value |
20x1 | $55,333 | 0.909 | $50,298 |
20x2 | $59,778 | 0.826 | $49,377 |
20x3 | $50,889 | 0.751 | $38,218 |
20x4 | $46,444 | 0.683 | $31,721 |
20x5 | $45,704 | 0.621 | $28,382 |
20x6 | $43,543 | 0.564 | $24,558 |
20x7 | $42,000 | 0.513 | $21,546 |
Total present value | $ 244,100 | ||
Less: Cash outflow for investment | $ 188,000 | ||
Net present value | $ 56,100 |
Table (4)
Note: Refer Appendix A (table III) for the present value factor.
Therefore, the net present value of new satellite dish is $56,100.
Want to see more full solutions like this?
Chapter 16 Solutions
Managerial Accounting: Creating Value in a Dynamic Business Environment
- Parker & Stone, Inc., is looking at setting up a new manufacturing plant in South Park to produce garden tools. The company bought some land six years ago for $2.8 million in anticipation of using it as a warehouse and distribution site, but the company has since decided to rent these facilities from a competitor instead. If the land were sold today, the company would net $3.2 million. The company wants to build its new manufacturing plant on this land; the plant will cost $14.3 million to build, and the site requires $825,000 worth of grading before it is suitable for construction. What is the proper cash flow amount to use as the initial investment in fixed assets when evaluating this project? Input area: Purchase price Appraised value Cost to build Grading costs (Use cells A6 to B9 from the given information to complete this question. Enter a "0" for any cost that should not be included.) Output area: Purchase price Appraised value Cost to build $2,800,000 $3,200,000 $14,300,000…arrow_forwardParker & Stone, Incorporated, is looking at setting up a new manufacturing plant in South Park to produce garden tools. The company bought some land six years ago for $7.5 million in anticipation of using it as a warehouse and distribution site, but the company has since decided to rent facilities elsewhere. If the land were sold today, the company would net $10.3 million. The company now wants to build its new manufacturing plant on this land; the plant will cost $21.5 million to build, and the site requires $900,000 worth of grading before it is suitable for construction. What is the proper cash flow amount to use as the initial investment in fixed assets when evaluating this project? Note: Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to the nearest whole number, e.g., 1,234,567. Cash flowarrow_forwardParker & Stone, Incorporated, is looking at setting up a new manufacturing plant in South Park to produce garden tools. The company bought some land six years ago for $8.4 million in anticipation of using it as a warehouse and distribution site, but the company has since decided to rent facilities elsewhere. If the land were sold today, the company would net $11.2 million. The company now wants to build its new manufacturing plant on this land; the plant will cost $22.4 million to build, and the site requires $990,000 worth of grading before it is suitable for construction. What is the proper cash flow amount to use as the initial investment in fixed assets when evaluating this project? Note: Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to the nearest whole number, e.g., 1,234,567.arrow_forward
- Aerotron Electronics is considering the purchase of a water filtration system to assist in circuit board manufacturing. The system costs $220,000. It has an expected life of 7 years at which time its salvage value will be $7,500. Operating and maintenance expenses are estimated to be $13,000 per year. If the filtration system is not purchased, Aerotron Electronics will have to pay Bay City $42,000 per year for water purification. If the system is purchased, no water purification from Bay City will be needed. Aerotron Electronics must borrow 1/2 of the purchase price, but they cannot start repaying the loan for 2 years. The bank has agreed to 3 equal annual payments, with the 1st payment due at the end of year 2. The loan interest rate is 8% compounded annually. Aerotron Electronics' MARR is 10% compounded annually. Part a What is the annual worth of this investment? $arrow_forwardParker & Stone, Inc., is looking at setting up a new manufacturing plant in South Park to produce garden tools. The company bought some land six years ago for $5.3 million in anticipation of using it as a warehouse and distribution site, but the company has since decided to rent these facilities from a competitor instead. If the land were sold today, the company would net $5.6 million. The company wants to build its new manufacturing plant on this land; the plant will cost $12.8 million to build, and the site requires $800,000 worth of grading before it is suitable for construction. What is the proper cash flow amount to use as the initial investment in fixed assets when evaluating this project? (Enter your answer in dollars, not millions of dollars, e.g. 1,234,567.) Cash flow amount $ eBook & Resources eBook: 10.2. Incremental Cash Flows Check my workarrow_forwardAerotron Electronics is considering the purchase of a water filtration system to assist in circuit board manufacturing. The system costs $40,000. It has an expected life of 7 years at which time its salvage value will be $7,500. Operating and maintenance expenses are estimated to be $2,000 per year. If the filtration system is not purchased, Aerotron Electronics will have to pay Bay City $12,000 per year for water purification. If the system is purchased, no water purification from Bay City will be needed. Aerotron Electronics must borrow half of the purchase price, but they cannot start repaying the loan for 2 years. The bank has agreed to three equal annual payments, with the first payment due at end of year 2. The loan interest rate is 8% compounded annually. Aerotron Electronics’ MARR is 10% compounded annually. Solve, a. What is the internal rate of return of this investment? b. What is the decision rule for judging the attractiveness of investments based on internal rate of…arrow_forward
- Aerotron Electronics is considering the purchase of a water filtration system to assist in circuit board manufacturing. The system costs $40,000. It has an expected life of 7 years at which time its salvage value will be $7,500. Operating and maintenance expenses are estimated to be $2,000 per year. If the filtration system is not purchased, Aerotron Electronics will have to pay Bay City $12,000 per year for water purification. If the system is purchased, no water purification from Bay City will be needed. Aerotron Electronics must borrow half of the purchase price, but it cannot start repaying the loan for 2 years. The bank has agreed to three equal annual payments, with the first payment due at the end of year 2. The loan interest rate is 8% compounded annually. Aerotron Electronics’ MARR is 10% compounded annually. Solve, a. What is the annual worth of this investment? b. What is the decision rule for judging the attractiveness of investments based on annual worth? c. Should…arrow_forwardValue Lodges is the owner of an economy motel chain. Value Lodges is considering building a new 200-unit motel. The cost to build the motel is estimated at $8,000,000; Value Lodges estimates furnishings for the motel will cost an additional $700,000 and will require replacement every 5 years. Annual operating and maintenance costs for the motel are estimated to be $800,000. The average rental rate for a unit is anticipated to be $40/day. Value Lodges expects the motel to have a life of 15 years and a salvage value of $900,000 at the end of 15 years. This estimated salvage value assumes that the furnishings are not new. Furnishings have no salvage value at the end of each 5-year replacement interval. Assuming average daily occupancy percentages of 50%, 60%, 70%, 80% for years 1 through 4, respectively, and 90% for the 5th through 15th years, MARR of 12%/yr, 365 operating days/year, and ignoring the cost of land, should the motel be built? Base your decision on an internal rate of return…arrow_forwardParker & Stone, Inc., is looking at setting up a new manufacturing plant in South Park to produce garden tools. The company bought some land 7 years ago for $8 million in anticipation of using it as a warehouse and distribution site, but the company has since decided to rent these facilities from a competitor instead. If the land were sold today, the company would net $10.2 million. The company wants to build its new manufacturing plant on this land; the plant will cost $12.2 million to build, and the site requires $1,428,000 worth of grading before it is suitable for construction. What is the proper cash flow amount to use as the initial investment in fixed assets when evaluating this project? A. $20,674,880 B. $25,019,400 C. $22,400,000 D. $20,972,000 E. $23,828,000arrow_forward
- Parker & Stone, Incorporated, is looking at setting up a new manufacturing plant in South Park to produce garden tools. The company bought some land 7 years ago for $5 million in anticipation of using it as a warehouse and distribution site, but the company has since decided to rent these facilities from a competitor instead. If the land were sold today, the company would net $9.6 million. The company wants to build its new manufacturing plant on this land; the plant will cost $12.2 million to build, and the site requires $1,344,000 worth of grading before it is suitable for construction. What is the proper cash flow amount to use as the initial investment in fixed assets when evaluating this project? Multiple Choice $21,800,000 $24,301,200 $23,144,000 $17,618,240 $20,456,000arrow_forwardAdidas is evaluating a proposal for a new product. If they launch the product, they will use an existing facility in the production process, which they previously acquired for $4 million. They currently lease it to a third party, and they expect to continue to do so if they don't use it for the new product. They rent it out for $102,000 and they expect that to remain flat for the foreseeable future. The project requires immediate investment in CAPX of $1.3 million, which will be depreciated on a straight-line basis over the next 10 years for tax purposes. The project will end after eight years, at which time they expect to salvage some of the initital CAPX and sell it for $469,000. The project requires immediate working capital investments equal to 10% of predicted first-year sales. After that, working capital will remain at 10% of the following year's expected sales. They expect sales to be $4.6 million in the first year and to stay constant for eight years. Total…arrow_forwardCablevision has been approached by the City of Miranda to run its cable operations in 2023. After negotiating with key parties, CableVision has made the following agreements: It will offer Mirada residents a basic set of 25 cable television stations at a rate of $46.50 per month. It will pay the city $1,400,000 per year plus $4.12 per cable subscriber per month to maintain the physical facilities. It will pay another company a monthly fixed fee of $70,000 plus $8.25 per cable subscriber per month to broadcast the 25 channels. CableVision estimates that operating costs for billing, program news mailings, etc. will be $125,000 per month plus 8% of monthly revenue. CableVision has several questions about its monthly revenues, costs, and profits in 2023. 1. Assuming a tax rate of 32%, how many monthly subscribers would be required for CableVision to earn $297,000 per month in 2023? 2. Some of CableVision's managers are uncertain about their estimate of monthly fixed operating costs.…arrow_forward
- EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT