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Capital Budgeting

 Self-Paced Overview

Net Cash Flows

Example 3:

Your company is thinking about investing in a new project with a depreciable base of $160,000 and an expected economic life of 4 years. Use straight line depreciation. The project will eliminate the need for two workers making $35,000 per year each. Fringes and overtime for each of the employees are $4000 per year. Waste and defects, currently $50,000 per year, will be cut in half. Maintenance expenses will go up by $1000 per year, and insurance costs will go up by $2000 per year. The tax rate is 15%.

Here you have a word problem. Perhaps the most efficient thing to do would be to estimate what the company would be doing if they don't invest in the new project, what they would be doing if they do invest in the new project, and then figure the differences.

  Without
New Project
With
New Project
Difference
Salaries $70,000 $0  
Fringes & OT $8,000 $0  
Waste $50,000 $25,000  
Maintenance ? + $1,000  
Insurance ? + $2,000  
Total $128,000 $28,000 $100,000
Yr ΔEBTD ΔDEPR = ΔEBT(1−t) = EAT + ΔDEPR = NCF
1-4 $100,000 $40,000 = $60,000(.85) = $51,000 + $40,000 = $91,000

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