Module 14 CT Problems CASH FLOWS, OTHER TOPICS IN CAPITAL BUDGETING, INTERNATIONAL BUSINESS FINANCE CT 14 - 1 CALCULATING FREE CASH FLOWS Mudarraj Computers is introducing a new product and has an expected cahnge in EBIT of SAR 522,000. The company has a 30 percent marginal tax rate. The project will produce SAR 105,000 of depreciation per year. In addition, the project will cause the following changes in year 1: DATA Change in EBIT 522.000 Tax rate 30% Depreciation 105.000 Accounts Receivable Inventory Accounts Payable Without Project 62.400 69.000 79.000 What is the project's free cash flow in year 1? Calculating Free Cash Flows: Change in EBIT Less: Change in taxes Plus: Change in depreciation Less Change in net working capital Less: Change in capital spending Free cash Flows CT 14 - 2 NEW PROJECT ANALYSIS With Project Change 76.000 82.500 97.200 13.600 13.500 18.200 Talhah Manufacturing is considering the purchase of a new production machine for SAR 529,000. The purchase of this machine will result in an increase in earnings before interest and taxes of SAR 91,000 per year. To operate this machine properly, workers would have to go through a brief training session that would cost SAR 17,000 after taxes. It would cost SAR 22,500 to install the machine properly. Also, because the machine is extremely efficient, its purchase would necessitate an increase in inventory or SAR 23,000. This machine has an expected life of 10 years, after which it will have no salvage value. Assume simplified straight-line depreciation and that this machine is being depreciated down to zero, a 35 percent marginal tax rate, and a required rate of return of 15 percent. DATA Change in EBIT Purchase Price Training Session Fee Installation Fee Increase in Inventory Life Salvage Value Depreciation Tax Rate Required rate of return 91.000 529.000 17.000 22.500 23.000 10 0 35% 15% A) What is the initial outlay associated with this project? Outflows Purchase Price Training Session Fee Installation Fee Increased Working Inventory Net Initial Outlay B) What are the annual after-tax cash flows associated with this project for years 1 through 9? Differential Annual Free Cash Flows (Years 1-9) Cash Flow Change in EBIT Change in taxes Change in depreciation Project's Free Cash Flows C) What is the terminal cash flow in year 10 (what is the annual after-tax cash flow in year 10 plus any additional cash flows associated with the termination of the project)? Terminal Free Cash Flow (Year 10) Inflows: Free Cash Flow in Year 10 Recapture of Working Capital (Inventory) Total Terminal Cash Flow D) Should the machine be purchased? Present Value of Free Cash Flows Years 1-9 Year 10 Less Initial Cost Net Present Value Decision: The machine should be purchased, the NPV > 0. CT 14 - 3 NEW PROJECT ANALYSIS Trans Global Corporation is considering the purchase of a new machine for SAR 422,000. The purchase of this machine will result in an increase in earnings before interest and taxes of SAR 97,000 per year. To operate this machine properly, workers would have to go through a brief training session that would cost SAR 12,200 after taxes. It would cost SAR 6,500 to install the machine properly. Also, because the machine is extremely efficient, its purchase would necessitate an increase in inventory or SAR 28,500. This machine has an expected life of 10 years, after which it will have no salvage value. Assume simplified straight-line depreciation and that this machine is being depreciated down to zero, a 32 percent marginal tax rate, and a required rate of return of 10 percent. DATA Change in EBIT Purchase Price Training Session Fee Installation Fee Increase in Inventory Life Salvage Value Depreciation Tax Rate Required rate of return A) What is the initial outlay associated with this project? Outflows Purchase Price Training Session Fee Installation Fee Increased Working Inventory Net Initial Outlay B) 97.000 422.000 12.200 6.500 28.500 10 0 32% 10% What are the annual after-tax cash flows associated with this project for years 1 through 9? Differential Annual Free Cash Flows (Years 1-9) Cash Flow Change in EBIT Change in taxes Change in depreciation Project's Free Cash Flows C) What is the terminal cash flow in year 10 (what is the annual after-tax cash flow in year 10 plus any additional cash flows associated with the termination of the project)? Terminal Free Cash Flow (Year 10) Inflows: Free Cash Flow in Year 10 Recapture of Working Capital (Inventory) Total Terminal Cash Flow D) Should the machine be purchased? Present Value of Free Cash Flows Years 1-9 Year 10 Less Initial Cost Net Present Value Decision: CT 12 - 4 RISK-ADJUSTED NPV Qusaiba Corporation is considering two mutually exclusive projects. Both require an initial outlay of SAR 22,500 and will operate for 5 years. Project A will produce expected cash flows of SAR 6,800 per year for years 1 through 5, whereas project B will produce expected cash flows of SAR 7,400 per year for years 1 thorough 5. Because project B is the riskier of the two projects, management of Qusaiba Corporation decided to apply a required rate of return of 20 percent to its evaluation but only a 7 percent required rate of return to project A. Determine each project's risk-adjusted net present value. Initial outlay Year 1 Year 2 Year 3 Year 4 Year 5 req. rate of return= Project A (22.500) 6.800 6.800 6.800 6.800 6.800 Project B (22.500) 7.400 7.400 7.400 7.400 7.400 7% 20% NPVa= NPVb= CT 14 - 5 SPOT EXCHANGE RATES Country Canada - dollar Japan - yen SAR 1 Quotes for Foreign Currencies Contract per day Spot 30 90 Spot SAR per Currency 2,7215 2,8514 2,6543 0,0289 Switzerland - franc 30 90 Spot 30 90 0,0290 0,0295 3,6572 3,7942 3,7815 A Saudi business needs to pay (a) 35,000 Canadian dollars, (b) 2 million Japanese yen, and (c) 49,000 Swiss francs to buinesses abroad today. What are the SAR payments to the respective countries? DATA Saudi business pays in local currency: Canadian dollars Japanese yen Swiss francs 35.000 2.000.000 49.000 In SAR: a) Canadian payment b) Japanese payment c) Swiss payment UAE business pays SAR 72,400, SAR 65,300, and SAR 84,700 to suppliers in, respectively, Japan, Switzerland, and Canada. Payments to the Japanese and Canadian suppliers is due in 90 days. The Swiss supplier is due in 30 days. How much, in local currencies, would the suppliers receive? DATA Saudi business pays in SAR: Japanese payment Swiss payment Canadian payment In local currency: 74.000 63.500 84.700 a) Japanese yen b) Swiss francs c) Canadian dollars CT 14 - 6 PURCHASING-POWER PARITY A pair of Men's Burton lace-up dress shoes cost SAR 510 in Saudi Arabia but costs GBP 88 in England. Assuming that purchasingpower parity (PPP) holds, how many SAR are required to purchase 1 GBP. Cost in Saudi Arabia = Cost in England = pair of Burton shoes 1 1 510 88 SAR 510 SAR GBP GBP SAR/shoes 510 88 SAR/GBP = (SAR/shoes)*(shoes/GBP) = shoes/GBP ming that purchasing- GBP/SAR
Purchase answer to see full attachment