Exam 9: Using Discounted Cash-Flow Analysis to Make Investment Decisions

CumChan has been in the chemical industry for the past 22 years.Current employment total is 65 workers, and the current economic situation (inflation of 4 percent, nominal discount rate) has forced the company to close its doors.CumChan however, must continue to pay health care costs for the next four years at a cost of $2,400 per worker, at an increasing rate of 3 percent above inflation.A consultant is called in to find the present value of this obligation.

As a project comes to its end, there is a disinvestment in working capital, which also generates positive cash flow as inventories are sold off and accounts receivable are collected.

The method of financing a project affects the determination of its cash flows for capital budgeting purposes.

CumChan forecasts revenues of $320,000 a year.Variable costs will be $90,000.Create an income statement for the shop based on the estimates.The tax rate is 40 percent.

Although the rule seems very straightforward, why is it stated that financial managers often make the mistake of discounting real cash flows with nominal rates? Mention one common example, and state the effect that this has on project evaluation.

Upon the sale of equipment at the end of its useful life, tax liability will be incurred whenever the book value of the equipment exceeds the sales price.

How does net working capital affect the NPV of a five-year project if working capital is expected to increase by $25,000 and the firm has a 15% cost of capital?