# Metro Corporation will spend $1 million for special manufacturing equipment. Shipping and...

## Question:

6.) Metro Corporation will spend $1 million for special manufacturing equipment. Shipping and installation charges will amount to $175,000 and an initial increase in net working capital of $50,000 will be required. The equipment will replace an existing machine that has a salvage value of $85,000 and a book value of $140,000. If Metro has a current marginal tax rate of 34%

What is the amount of the initial outlay for this project?

a. -$1,121,300

b. -$1,328,700

c. -$1,158,700

d. -$1,225,000

e. -$1,021,300

7.) Shell Biotech Corporation is considering two mutually exclusive capital investment projects. Project 1 costs $75, 000, and would produce differential cash flows of $16, 200 for each of the next 9 years. Project 2 also costs $75, 000, but would produce differential cash flows of $14, 000 for each of the next 12 years. If Shell's cost of capital is 11%, which alternative should be chosen?

a. Project 1 should be accepted.

b. Project 2 should be accepted.

c. Both projects should be accepted.

d. Neither is acceptable.

8.) Projects 1 and 2 can not be compared. Jefferson Corporation is purchasing equipment with a 10-year life which will increase revenue by $38, 000 per year and increase expenses by $21, 000 per year. The cost of the project is $24, 000, and the equipment has a salvage value of $9, 000 at the end of the tenth year. The project will require a $6, 000 investment in net working capital immediately. The equipment will be depreciated for 10 years using a simplified straight line. Jefferson's marginal tax rate is 35%. Calculate the total year 10 net cash flow, including both the last annual cash flow and the project's terminal cash flow.

a. $23,740

b. $21,340

c. $20,890

d. $17,740

e. $11,890

## Operating cash flow:

Operating cash flow (OCF) is a measurement that calculates the efficiency of a business to produce cash in each year from its principal operations and business activities. In other words, it shows how much cash flow is generated from the business operations (other than investment activities or asset sale/purchase).

## Answer and Explanation:

OCF is calculated as: *Operating Cash Flow = Net Income + Non-Cash Expenses - Increase in Working Capital*

6.) Metro Corporation will spend $1 million for special manufacturing equipment. Shipping and installation charges will amount to $175,000 and an initial increase in net working capital of $50,000 will be required. The equipment will replace an existing machine that has a salvage value of $85,000 and a book value of $140,000. If Metro has a current marginal tax rate of 34%

what is the amount of the initial outlay for this project?

Equipment cost = $1,000,000

Shipping and installation charges = $175,000

Initial increase in net working capital = $50,000

After tax proceed from the asset sale =85000+(140000-85000)*0.34 = $ 103,700

Net cash flow at year 0 = -$1,000,000 - $175,000 - $50 000 + $ 103,700 =** -$ 1,121,300**

**Option (a) correct**

7.) Shell Biotech Corporation is considering two mutually exclusive capital investment projects. Project 1 costs $75,000 and would produce differential cash flows of $16,200 for each of the next 9 years. Project 2 also costs $75,000 but would produce differential cash flows of $14,000 for each of the next 12 years. If Shell's cost of capital is 11%, which alternative should be chosen?

We calculate the NPV of each project

{eq}NPV(1) = -$75, 000 + $16, 200*PVIFA (11\%,~ 9 ~years) {/eq}

{eq}= -$75, 000 + $16, 200*5.53705 {/eq}

{eq}= $ 14,700 .........................(1) {/eq}

{eq}NPV(2) = -$75, 000 + $14, 000*PVIFA (11\%, ~12 ~years) {/eq}

{eq}= -$75, 000 + $14, 000* 6.20652 {/eq}

{eq}=$ 11,891 .............(2) {/eq}

As (1) > (2) project (1) to be selected.

**Option (a) correct **

.

8.) Jefferson Corporation is purchasing equipment with a 10-year life which will increase revenue by $38,000 per year and increase expenses by $21,000 per year. The cost of the project is $24,000 and the equipment has a salvage value of $9,000 at the end of the tenth year. The project will require a $6,000 investment in net working capital immediately. The equipment will be depreciated for 10 years using a simplified straight line. Jefferson's marginal tax rate is 35%. Calculate the total year 10 net cash flow, including both the last annual cash flow and the project's terminal cash flow.

Net incremental revenue = $38,000 - $21,000 = $17,000

Cost of project =$24,000

Annual depreciation = $24,000/10 = $2,400 per year

Incremental OCF in year 10 = $17,000*(1-35%) + 35%*$2,400 = $ 11,890

After tax salvage value at year 10 = $9, 000*(1-35%) = $ 5,850

Recovery of W/C = $6, 000

So, year 10 net cash flow = $ 11,890 + $ 5,850 +$6, 000 = $ 23,740

**Option (a ) is correct.**

#### Learn more about this topic:

from Finance 101: Principles of Finance

Chapter 10 / Lesson 4