This exercise parallels the machine-purchase decision for the Mendoza Company that is discussed in the body of the chapter. Assume that Mendoza is exploring whether to enter a complementary
This exercise parallels the machine-purchase decision for the Mendoza Company that is discussed in the body of the chapter. Assume that Mendoza is exploring whether to enter a complementary line of business. The existing business line generates annual cash revenues of approximately $5,000,000 and cash expenses of $3,600,000, one-third of which are labor costs. The current level of investment in this existing division is $12,000,000. (Sales and costs of this division are not affected by the investment decision regarding the complementary line.)
Mendoza estimates that incremental (noncash) net
The CFO of the company estimates that new machinery costing $2,500,000 would need to be purchased. This machinery has a seven-year useful life and an estimated salvage (terminal) value of $400,000. For tax purposes, assume that the Mendoza Company would use the straight-line method (with estimated salvage value considered in the calculation).
Assume, further, that the weighted-average cost of capital (WACC) for Mendoza is 14% (after-tax) and that the combined (federal and state) income tax rate is 40%. Finally, assume that the new business line is expected to generate annual cash revenue of $3,600,000.
Required:
Determine relevant cash flows (after-tax) at each of the following three points: (1) project initiation, (2) project operation, and (3) project disposal (termination). For purposes of this last calculation, you can assume that the asset is sold at the end of its useful life for the salvage value used to establish the annual straight-line
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Hi, number 3 still appears to be unanswered for this problem. How do you determine relevant cash flow (after-tax) at project disposal (termination)?
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