Gradual Inc, is considering investing 3750 in new equipment that will fall into
ID: 2744968 • Letter: G
Question
Gradual Inc, is considering investing 3750 in new equipment that will fall into the 10 year MACRS class. The equipment would be installed in an empty building the firm purchased two years ago for 3000 that it was planning to sell for 3500. Note that no depreciation has been recognized on the vacant building and that if Gradual buys the equipment, it will no longer sell the building. The new equipment is expected to generate revenues of 50000 one year from today and revenues would grow at an annual rate of 2%. Variable costs would equal 7% of sales and fixed costs will equal 7875 per year. If Gradual invests in the new equipment, the working capital associated with the new equipment will be as shown below.
Year 0 1 2 3 4 5
Cash 0 3000 3195 3447 3468 3506
Acct. Receivable 0 1625 1717 1784 1762 1876
Inventory 0 6375 6577 6166 7169 7455
Acct. Payable 0 6250 6596 6727 7139 7385
If Gradual's corporate tax rate equals 35%, set up the equations and plug in the relevant numbers needed to calculate the firm's unlevered net income and free cash flow today and four years from today if it invests in the new equipment. Note: No calculations are necessary. Just set everything up.
Explanation / Answer
Year 1 2 3 4 5 Revenue 50000 Revenue of Year 1 X 1.02 Revenue of Year 2 X 1.02 Revenue of Year 3 X 1.02 Revenue of Year 4 X 1.02 Less: Variable Cost Revenue for the year x 0.07 Revenue for the year x 0.07 Revenue for the year x 0.07 Revenue for the year x 0.07 Revenue for the year x 0.07 Less: Fixed Cost 7875 7875 7875 7875 7875 Less: Depreciation As per MACRS As per MACRS As per MACRS As per MACRS As per MACRS Earning Before Tax Revenue - Variable Cost - Fixed Cost - Depreciation Revenue - Variable Cost - Fixed Cost - Depreciation Revenue - Variable Cost - Fixed Cost - Depreciation Revenue - Variable Cost - Fixed Cost - Depreciation Revenue - Variable Cost - Fixed Cost - Depreciation Less: Tax @ 35% 35% of Earnings Before tax 35% of Earnings Before tax 35% of Earnings Before tax 35% of Earnings Before tax 35% of Earnings Before tax Net Income Earnings Before Tax - Tax Earnings Before Tax - Tax Earnings Before Tax - Tax Earnings Before Tax - Tax Earnings Before Tax - Tax Add: Change in Net Working Capital Cash + Acct. Receivable + Inventory - Acct Payble Change in cash compared to previous year + Change in Acct. Receivable compared to previous year + Change in inventory compared to previous year - Change in Acct. Payable compared to previous year Change in cash compared to previous year + Change in Acct. Receivable compared to previous year + Change in inventory compared to previous year - Change in Acct. Payable compared to previous year Change in cash compared to previous year + Change in Acct. Receivable compared to previous year + Change in inventory compared to previous year - Change in Acct. Payable compared to previous year Change in cash compared to previous year + Change in Acct. Receivable compared to previous year + Change in inventory compared to previous year - Change in Acct. Payable compared to previous year Add: Depreciation Depreciation for the year Depreciation for the year Depreciation for the year Depreciation for the year Depreciation for the year Less: Cash Outflow Cost of Equipment + Cost of building 0 0 0 0 Free Cash Flow Net Income + Change in NWC + Depreciation - Cash outflow for the year Net Income + Change in NWC + Depreciation - Cash outflow for the year Net Income + Change in NWC + Depreciation - Cash outflow for the year Net Income + Change in NWC + Depreciation - Cash outflow for the year Net Income + Change in NWC + Depreciation - Cash outflow for the year
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