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
...

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