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CASE STUDY 2 Application of Capital Budgeting Decision Rules Company X is proposing the following capital budgeting project: Total depreciable ccst Equipment: 220,000 Shipping and installation: $30,000 Changes in working capital Inventories will nse by $25,000 Accounts payable will rise by $5,000 Effect on operations New sales: 100,000 umits/year @ $2/mit Variable cost: 60% of sales Life of the projec. Economic life: 4 years Depreciable life: MACRS 3-year class Salvage value: $25,000 Tax rate:40% WACC: 11% Determining Project Value Estimate the re.evant cash flows recited to the project Calculating annual operating cash flows (OCF) Identifying changes in werking capital (NWC). Calculating terminal cash flows (TCF) that incindes affer-tax saivage value and return (reimbursement) of NWC. 1 2 3 4 Initial OCF1 OCF2 OCF3 OCF4 Costs + Terminal CFs NCFo NCF1 NCF2 NCF3 NCF2 After you solve the case, please, shortly answer to the following questions: 1. What is the role of NWC? How is NWC recovered in the last year? 2. Hew do we define Salvage Value? Is there always taxes on Salvage Value and when? 3. Should financing effects (interest. dividend) be included in cash flows? If yes. why? \ 4. What decision should be tacen by the management tased or your results? Which cf the capital budgeting rules :3 most widely used? 22000

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