The B. B. Dome Project

A Capital Budgeting Cash Flow Problem

Created by Pamela Peterson Drake

The B. Bowden Company is evaluating the purchase of a stadium, the B. B. Dome. The stadium would cost Bowden \$1 million and would be depreciated for tax purposes using straight-line over twenty years.

It is expected that the stadium will increase B. Bowden revenues by \$400,000 per year, but would also increase expenses by \$200,000 per year. B. Bowden would be expected to increase its working capital by \$20,000 to accomodate the increased investment in ticket accounts receivable. B. Bowden Company intends to sell the stadium to the city after ten years for \$600,000.

The marginal tax rate of B. Bowden is 40%. For purposes of identifying the timing of cash flows, consider the purchase to be made at the end of 2000, the first year of operations the year 2001, and the last year of operations the year 2010.

The B. B. Dome Project

Analysis of Information and Solustions

The B. Bowden Company is evaluating the purchase of a stadium, the B. B. Dome.

This is a purchase of an asset, not a replacement decision.

The stadium would cost Bowden \$1 million and would be depreciated for tax purposes using straight-line over twenty years.

Initial outlay of \$1,000,000, with depreciation of \$1,000,000 / 20 = \$50,000 per year.

It is expected that the stadium will increase B. Bowden revenues by \$400,000 per year, but would also increase expenses by \$200,000 per year.

Without considering depreciation, this would be a cash inflow of \$200,000 each year, less any taxes on the change in income.

B. Bowden would be expected to increase its working capital by \$20,000 to accomodate the increased investment in ticket accounts receivable.

Investment cash outflow of \$20,000 initially, but investment cash inflow of \$20,000 a the end of the project.

B. Bowden Company intends to sell the stadium to the city after ten years for \$600,000.

Cash inflow of \$600,000 at the end of the project, less any taxes. Book value at the end of 10 years is \$500,000. Gain on sale is \$100,000.

The marginal tax rate of B. Bowden is 40%.

The B. B. Dome Project

Analysis of Cash Flows

 2000 2001-2009 2010 INVESTMENT CASH FLOWS Initial cost -\$1,000,000 Less: Change in working capital -\$20,000 +\$20,000 Sale of stadium +\$600,000 Less: Tax on sale of stadium -40,000 Investment cash flows -\$1,020,000 +\$580,000 OPERATING CASH FLOWS Increase in revenues \$400,000 \$400,000 Less: Increase in expenses 200,000 200,000 Less: Change in depreciation 50,000 50,000 Change in taxable income \$150,000 \$150,000 Less: change in taxes 60,000 60,000 Change in income after taxes \$90,000 \$90,000 Add: change in depreciation \$50,000 \$50,000 Change in operating cash flows \$140,000 \$140,000 Net cash flows -\$1,020,000 +\$140,000 +\$720,000