Solutions to Rockafeller Music Company

Integrative Capital Budgeting Problem

 
Year
Item012345
Buy and sell the building-$1,000,000    +$800,000
Buy and sell the equipment-500,000    +150,000
Tax on the sale of the building    -20,000
Tax on the sale of the equipment     +40,000
Change in working capital-100,000    +100,000
Acquisition and disposiiton cash flows-$1,600,000    +$1,070,000
Change in revenues $400,000$400,000$400,000$400,000$400,000
Change in expenses 160,000160,000160,000160,000160,000
Change in depreciation 100,000100,000100,000100,000100,000
Change in taxable income $140,000$140,000$140,000$140,000$140,000
Change in taxes 56,00056,00056,00056,00056,000
Change in income after taxes $84,000$84,000$84,000$84,000$84,000
Add: Change in depreciation 100,000100,000100,000100,000100,000
Change in operating cash flow +$184,000+$184,000+$184,000+$184,000+$184,000
Change in net cash flow-$1,600,000+$184,000+$184,000+$184,000+$184,000+$1,254,000
PV of cash flow-$1,600,000+$167,273+$152,066+$138,242+$125,674+$778,635

Net present value = -$238,109

Internal rate of return = 5.573%

Notes:

  1. Depreciation
    1. Depreciation on building = $1,000,000 / 20 = $50,000
    2. Depreciation on equipment = $500,000 / 10 = $50,000
  2. Book values
    1. Book value of building = $1,000,000 - (5 x 50,000) = $750,000
    2. Book value of equipment = $500,000 - (5 x 50,000) = $250,000
  3. Tax on sales of property and equipment
    1. Tax on sale of building = 0.40 ($800,000 - 750,000) = $20,000
    2. Tax on sale of equipment = 0.40 ($150,000 - 250,000) = -$40,000