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Suppose a company has hired you to estimate the cash flows arising from a proposed capital project by replacing old equipment with a $0 market value
Suppose a company has hired you to estimate the cash flows arising from a proposed capital project by replacing old equipment with a $0 market value and a book value of $100,000, and you have been handed the relevant data below. The project being considered has a 5-year tax life, and at the end of year 5 the asset will be worthless (i.e. salvage value =0). The CFO suggests that you depreciate the asset by using the straight-line method over the 5 year life of the project. Revenues and other operating costs are as noted below, and will be constant over the period.
Equipment cost: $1,750,000;Book value of old equipment: $100,000
Delivery and installation cost of equipment and remove old equipment: $500,000;
Straight-line depreciation rate: 20% (5-year);Inflation: 3% per year.
Sales unit in the 1st year: 25,000Sales price per unit $120
Cost per unit: $80Sales growth per year: 6%
Operating costs (excluding depreciation, assume it is fix costs): $300,000;Tax rate: 34%
The project requires a working capital equal to 9% of next year’s sales.
1. What are annual free cash flows for the next five years? Hint: find CF0 to CF5
