The president of Fly-by-Night Airlines has asked you to evaluate the proposed acquisition of a new jet. The jet’s price is $40 million, and it is classified in the 10-year MACRS class. The purchase of the jet would require an increase in net working capital of $200,000. The jet would increase the

Question

The president of Fly-by-Night Airlines has asked you to evaluate the proposed acquisition of a new jet. The jet’s price is $40 million, and it is classified in the 10-year MACRS class. The purchase of the jet would require an increase in net working capital of $200,000. The jet would increase the firm’s before-tax revenues by $20 million per year, but would also increase operating costs by $5 million per year. The jet is expected to be used for three years and then sold for $25 million. The firm’s marginal tax rate is 40%.

a. What is the amount of the investment outlay required at the beginning of the project?

b. What is the amount of the operating cash flow each year?

c. What is the amount of the nonoperating cash flow in the third year?

d. What is the amount of the net cash flow for each year?

a. What is the amount of the investment outlay required at the beginning of the project?

b. What is the amount of the operating cash flow each year?

c. What is the amount of the nonoperating cash flow in the third year?

d. What is the amount of the net cash flow for each year?

Accepted Answer

See the table below for details.

a. $40.2 million

b. $11.4 million, $13.320 million, and $12.456 million

c. $15.984 million

d. −$40.2 initially, and then $15.4 million, $20.52 million, and $42.632 million

	Year
	0	1	2	3
Initial cost	−$40,000,000
Change in working capital	−200,000			$200,000
Sale price				25,000,000
Tax on gain on sale				−784,000
Investment cash flows		$0	$0	$24,416,000
Change in revenues		$20,000,000	$20,000,000	$20,000,000
Change in operating costs		5,000,000	5,000,000	5,000,000
Change in depreciation		4,000,000	7,200,000	5,760,000
Change in taxable income		$19,000,000	$22,200,000	$20,760,000
Change in taxes		7,600,000	8,880,000	8,304,000
Change in income after taxes		$11,400,000	$13,320,000	$12,456,000
Add: depreciation		4,000,000	7,200,000	5,760,000
Operating cash flows		$15,400,000	$20,520,000	$18,216,000
Net cash flows	−$40,200,000	$15,400,000	$20,520,000	$42,632,000

Note:

	Year
	1	2	3
Book value of the jet, end of period Tax on gain on sale	$36,000,000	$28,800,000	$23,040,000
Sales price			$25,000,000
Book value			23,040,000
Gain			$1,960,000
Tax rate			40%
Tax on gain			$784,000

Question 13.14: The president of Fly-by-Night Airlines has asked you to eval...

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