Principles of Corporate Finance_ 12th Edition

bre44380_ch06_132-161.indd 152 09/30/15 12:46 PM

152 Part One Value

Select problems are available in McGraw-Hill’s Connect.

Please see the preface for more information.

BASIC

1. Cash flows Which of the following should be treated as incremental cash flows when
   deciding whether to invest in a new manufacturing plant? The site is already owned by the
   company, but existing buildings would need to be demolished.
   a. The market value of the site and existing buildings
   b. Demolition costs and site clearance
   c. The cost of a new access road put in last year
   d. Lost earnings on other products due to executive time spent on the new facility
   e. A proportion of the cost of leasing the president’s jet airplane
   f. Future depreciation of the new plant
   g. The reduction in the corporation’s tax bill resulting from tax depreciation of the new plant
   h. The initial investment in inventories of raw materials
   i. Money already spent on engineering design of the new plant


2. Real and nominal flows Mr. Art Deco will be paid $100,000 one year hence. This is a
   nominal flow, which he discounts at an 8% nominal discount rate:

PV = 100,000_______

1.08

= $92,593

The inflation rate is 4%.

Calculate the PV of Mr. Deco’s payment using the equivalent real cash flow and real dis-

count rate. (You should get exactly the same answer as he did.)

3. Cash flows True or false?
   a. A project’s depreciation tax shields depend on the actual future rate of inflation.
   b. Project cash flows should take account of interest paid on any borrowing undertaken to
   finance the project.
   c. In the U.S., income reported to the tax authorities must equal income reported to
   shareholders.
   d. Accelerated depreciation reduces near-term project cash flows and therefore reduces proj-
   e c t N P V.


4. Depreciation How does the PV of depreciation tax shields vary across the recovery-period
   classes shown in Table 6.4? Give a general answer; then check it by calculating the PVs of
   depreciation tax shields in the five-year and seven-year classes. The tax rate is 35% and the
   discount rate is 10%.


5. Working capital The following table tracks the main components of working capital over
   the life of a four-year project.

● ● ● ● ●

PROBLEM

SETS

2016 2017 2018 2019 2020

Accounts receivable 0 150,000 225,000 190,000 0

Inventory 75,000 130,000 130,000 95,000 0

Accounts payable 25,000 50,000 50,000 35,000 0

Calculate net working capital and the cash inflows and outflows due to investment in work-

ing capital.