Giant Corp. is considering a project that requires a $1,500 initial cost for a n
ID: 2655235 • Letter: G
Question
Giant Corp. is considering a project that requires a $1,500 initial cost for a new machine that will be depreciated straight line to a salvage value of 0 on a 5-year schedule. The project will require a one-time increase in the level of net working capital of $300. The project will generate an additional $1,600 in revenues and $700 in operating expenses each year. The project will end at the end of year 2, at which time the machinery is expected to be sold for $800. Giant’s tax rate is 50%.
A. In a discounted cash flow analysis of this project, what would be the projected Year 0 free cash flow?
B. In a discounted cash flow analysis of Giant Corp.’s project described in the problem above, what would be the projected Year 1 free cash flow?
C. In a discounted cash flow analysis of Giant Corp.’s project described in the problem above, what would be the projected Year 2 free cash flow?
Giant Corp. is considering a project that requires a $1,500 initial cost for a new machine that will be depreciated straight line to a salvage value of 0 on a 5-year schedule. The project will require a one-time increase in the level of net working capital of $300. The project will generate an additional $1,600 in revenues and $700 in operating expenses each year. The project will end at the end of year 2, at which time the machinery is expected to be sold for $800. Giant’s tax rate is 50%.
A. In a discounted cash flow analysis of this project, what would be the projected Year 0 free cash flow?
B. In a discounted cash flow analysis of Giant Corp.’s project described in the problem above, what would be the projected Year 1 free cash flow?
C. In a discounted cash flow analysis of Giant Corp.’s project described in the problem above, what would be the projected Year 2 free cash flow?
Explanation / Answer
A ) Year o free cash flow = Machine cost +net working capital
= 1500 +300
= $ 1800
B)Year 1 cash flow = (Revenue -expense -Depreciation
= 1600 - 700 - 300
= $ 600
Tax @50$ = 300
Free cash flow for year 1 = cash flow -tax +depreciation
= 600 - 300 + 300
= $ 600
C)year 2 :same as year 1
Free cash flow = $ 600
Add:salavge value (net of tax shield) 850
Net working capital realised 300
Free cash flow for year 2 = $1750
**Depreciation = 1500 /5 = $ 300 per year)
**Salvage net of tax shield = (sale value -book value)
= 800 - [1500 -300 -300 ]
= 800- 900
= -100 (loss)
Tax shield available on loss = 100 *50$ = 50
so net inflow = sale value +tax shield
= 800+ 50
= 850
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