Pantaloon Beer is considering opening a microbrewery near campus. To open the br
ID: 2785177 • Letter: P
Question
Pantaloon Beer is considering opening a microbrewery near campus. To open the brewery, they must purchase $250 in equipment. Shipping of the equipment will cost $40 and installation of the equipment will be $30. Pantaloon will lease a building for $384 per year. The building will need modifications costing $100. Both the modifications and equipment are depreciated using the 5 year MACRS schedule. Pantaloon will operate the brewery for four years, and then expects to sell the brewery to an investor for $500 plus any working capital. The firm will have some one-time expenses in year 1 of $120, primarily licenses and legal fees. To operate the brewery, Pantaloon will need an increase in Inventory of $17, an increase of Accounts Receivables of $19, and will have an increase in Accounts Payable of $15. Working capital will be recovered when we sell the brewery. Annual sales will begin at $600, the increase at $600 per year. Thus year 2 sales are $1200, year 3 are $1800 and year 4 are $2400. Cost of Goods Sold (excluding overhead, depreciation, and lease payments) are 60% of annual sales. To operate the company, executives and administrators must be hired, at an annual fixed cost of $500. Over the past two years, Pantaloon has been testing the concept by using a contract brewer. Last year’s sales were $100 with a cost of goods sold of $120. 40% of the project financing will come from a three-year 6% annual coupon bond. The firm needs new equity investors to fund the expansion and Pantaloon has only been able to find one equity investor. This equity investor requires that the firm have audited financial statements. The outside investor gets to choose the auditor and the auditor would cost the company $30 per year. The firm’s tax rate is 30%. The cost of capital is 13%. What are the Initial Cash Flows in Year 0? What are the Operating Cash Flows in Year 2? What are the Terminal Cash Flows in Year 4? (I want only Terminal Cash Flows, not operating cash flows in year 4)
Explanation / Answer
1. Initial Cash flow in Year 0 = Cost of equipment + Shipping Cost + Installation cost + Modification Cost + Net Working Capital
=> $250 + $40 + $30 + $100 + $51 = $471
Net working capital = Increase in Inventory + Increase in Accounts Receivables - Increase in Accounts Payable
=> $17 + $19 + $15 = $51
2.
5 Years Depreciation Schedule
Year
Basis
%
Depreciation Expense
Accumulated Depreciation
Ending Book Value
1
$350
20.000%
$70
$70
$280
2
$350
32.000%
$112
$182
$168
3
$350
19.200%
$67
$249
$101
4
$350
11.520%
$40
$290
$60
5
$350
11.520%
$40
$330
$20
6
$350
5.760%
$20
$350
$0
Operating Cash Flow in Year 2
Sales
$1,200.00
Less: Cost of Goods Sold
$720.00
Less: Annual fixed cost
$500.00
Less: Lease Payment
$384.00
Less: Depreciation
$112.00
Earnings Before Tax
-$516.00
Less: Tax @ 30%
-$154.80
Net Income
-$361.20
Add: Depreciation
$112.00
Operating Cash Flow
-$249.20
Depreciation in year 2 as per MACRS schedule = Depreciable value x 32% => $350 x 32% = $112
3. Terminal cash flow is the cash flow occurring due upon closure of the project. Since the brewery can be sold for $500 plus any working capital, the terminal cash flow will after-tax cash flow occurring due to this activity.
In case, the salvage value ($500) is more than the book value of depreciable amount, a tax of 30% will be levied on any excessive amount
Book Value at the end of year 4 = $60
So, the terminal cash flow = $500 – [($500 - $60) x 30%] + Net Working Capital
=> $500 - $132 + $51 = $419
5 Years Depreciation Schedule
Year
Basis
%
Depreciation Expense
Accumulated Depreciation
Ending Book Value
1
$350
20.000%
$70
$70
$280
2
$350
32.000%
$112
$182
$168
3
$350
19.200%
$67
$249
$101
4
$350
11.520%
$40
$290
$60
5
$350
11.520%
$40
$330
$20
6
$350
5.760%
$20
$350
$0
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.