2-3) In the spring of 2010, Jemison Electric was considering an investment in a new distribution center. Jemison’s CFO anticipates additional earnings before interest and taxes (EBIT) of $100,000 for the first year of operation of the center in 2011, and, over the next five years, the firm estimates that this amount will grow at a rate of 5% per year. The distribution center will require an initial investment of $400,000 that will be depreciated over a five-year period toward a zero salvage value using straight-line depreciation of $80,000 per year. Furthermore, Jemison expects to invest an amount equal to the firm’s annual depreciation expense to maintain the physical plant. These additional capital expenditures will also be depreciated over a period of five years toward a zero salvage value. Jemison’s CFO estimates that the distribution center will need additional net working capital equal to 20% of new EBIT (i.e., the change in EBIT from year to year).

Assuming the firm faces a 30% tax rate; calculate the project’s annual project free

cash flow (FCF) for each of the next five years.

2-7) CT Computers Inc. is considering whether to begin offering customers the option to have their old personal computers recycled when they purchase new systems. The recycling system would require CT to invest $600,000 in the grinders and magnets used in the recycling process. The company estimates that for each system it recycles. It would generate $1.50 in incremental revenues from the sale of scrap metal and plastics. The machinery has a five-year useful life and will be depreciated using straight-line depreciation toward a zero salvage value. CT estimates that in the first year of the recycling investment, it could recycle 100,000 PCs and that this number will grow by 25% per year over the remaining four-year life of the recycling equipment. CT uses a 15% discount rate to analyze capital expenditures and pays taxes equal to 30%.

a. What are the project cash flows? You can assume that the recycled PCs cost CT nothing.

b. Calculate the NPV and IRR for the recycling investment opportunity. Is the investment a good one based on these cash flow estimates?

c. Is the investment still a good one if the Year 1units recycled is only 75,000?

d. Redo your analysis for a scenario in which CT incurs a cost of $0.20 per unit to dispose of the toxic elements from the recycled computers. What is your recommendation under these circumstances?

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