土豆妮

In the last year of the new factory project, cash flows will be closest to:

A) $90.21 million.

B) $88.00 million.

C) $95.71 million.

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To calculate cash flows for Year 6, we must determine both the operating cash flow and the terminal value. Based on $205 million in sales, $65 million in fixed costs, variable costs equal to 40 percent of sales, and a 34 percent tax rate, the operating cash flow = ($205 ? $65 ? $82) × (1 ? 34%) = $38.28 million. Depreciation expenses are one year’s share of the start-up expenses depreciated on a straight line over six years, and one year’s share of the equipment purchased in Year 1, depreciated on a straight line over five years. Depreciation = ($85 million for building ? $35 million salvage value) / 6 + $20 million for equipment ? $3.25 million salvage value) / 5 = $11.68. Operating cash flow = cash from factory operations + (depreciation × t) = $42.25 million.

The terminal value represents the salvage value of the building and equipment, adjusted for taxes, plus the return of the $7.5 million in working capital added in Year 2. Terminal value = ($35 million for the building + $3.25 million for the equipment) + $7.5 million for working capital = $45.75 million. Since the market value and book value of the building and equipment are the same, there is no taxable gain or loss, and no need for a tax adjustment in the terminal-value calculation.

Year 6 Cash flows = $88.00 million. (Study Session 8, LOS 28.a)

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Which of the following statements about the effect of inflation on the capital-budgeting process is most accurate?

Statement 1: Inflation is reflected in the WACC, but future cash flows should still be adjusted when calculating the NPV.
Statement 2: Inflation will cause the WACC to decrease.
Statement 3: Incorporating inflation in the cash flows tends to exert downward pressure on the NPV.
Statement 4: Because the IRR does not depend on the WACC, inflation has no effect on it.

A) Statement 1 only.

B) Statements 3 and 4.

C) Statements 2 and 3.

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Inflation causes the WACC to increase, so Statement 2 is false. Because the WACC reflects inflation, future cash flows must be adjusted to avoid a downward bias, so Statement 1 is true. Both the NPV and the IRR will tend to decline if cash flows are not adjusted — Statements 3 and 4 are false. (Study Session 8, LOS 28.b)

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