Managerial Accounting Chapter 16

CHAPTER 16: CASE STUDY 16-58Inflation; NPV; Real Dollars

Rene MorelEmbry-Riddle Aeronautical University Online

MBAA 517Instructor: Dr. Ana Machuca

Activity 5.5 – Case Study 5 – 9-45

Managerial Accounting Chapter 16

In this activity, you will solve a case out of your textbook, Managerial Accounting. The intent of the Case Studies is to show how to analyze module related managerial accounting financial data in an organizations setting. For this case study, you will be able to demonstrate your ability to correctly calculate a master budget.

Your seventh Case Study will be Case 16-58: Inflation, NPV, Real Dollars. This case can be found at the end of Chapter 16. The primary focus of this case study is to prepare net present value analysis and discuss ethical considerations. Your assignment is to complete the requirements identified for Case 16-58: 1 – 3.

Pensacola Cablevision Company provides television cable service to two counties in the Florida panhandle. The firm’s management is considering the construction of a new satellite dish in December of 20x0. The new antenna would improve reception and the service provided to customers. The dish antenna and associated equipment will cost $200,000 to purchase and install. The company’s old equipment, which is fully depreciated, can be sold now for $20,000. The company president expects the firm’s improved capabilities to result in additional revenue of $80,000 per year during the dish’s useful life of seven years. The incremental operating expenses associated with the new equipment are projected to be $10,000 per year. These incremental revenues and expenses are in real dollars.

The new satellite dish will be depreciated under the MACRS depreciation schedule for the 5-year property class. The company’s tax rate is 40 percent.

Pensacola Cablevision’s president expects the real rate of interest in the economy to remain stable at 10 percent. She expects the inflation rate, currently running at 20 percent, to remain unchanged.

Required:

1. Compute the price index for each year from 20x1 through 20x7, using 1.0000 as the index for 20x0.

Computing the price index from 20x1 to 20x7 we get:

Year Formula Price Index20x0 1.000 1.00020x1 1.20^1 1.20020x2 1.20^2 1.44020x3 1.20^3 1.72820x4 1.20^4 2.07420x5 1.20^5 2.48820x6 1.20^6 2.98620x7 1.20^7 3.583

Managerial Accounting Chapter 16

2. Prepare a schedule of after-tax cash flows measured in real dollars.

Cost of New Satellite Dish

($200,000.00)

Salvage Value $20,000.00 Incremental tax ($8,000.00)

($188,000.00)

Incremental Tax Inflow (annually)$80,000-$10,000 x 0.60 $42,000.00

Year Formula Price Index

Incremental Cash Flow in Real Dollars

MACRS Depreciatio

nTax

Savings

Depreciation Tax Shield

in Real Dollars

20x0 1.000 1.000 ($188,000.00) $0.00 $0.00 $0.00 20x1 1.20^1 1.200 $42,000.00 $40,000.00 $16,000.00 $13,333.33 20x2 1.20^2 1.440 $42,000.00 $64,000.00 $25,600.00 $17,777.78 20x3 1.20^3 1.728 $42,000.00 $38,400.00 $15,360.00 $8,888.89 20x4 1.20^4 2.074 $42,000.00 $23,040.00 $9,216.00 $4,444.44 20x5 1.20^5 2.488 $42,000.00 $23,040.00 $9,216.00 $3,703.70 20x6 1.20^6 2.986 $42,000.00 $11,520.00 $4,608.00 $1,543.21 20x7 1.20^7 3.583 $42,000.00 $0.00 $0.00 $0.00

3. Compute the net present value of the proposed new satellite dish using cash flows measured in real dollars. Use a real discount rate equal to the real interest rate.

The real interest rate is 0.10.

YearDiscount

factor

Ater-Tax Cash Flow in Real

Dollars Present Value20x0 1 ($188,000.00) ($188,000.00)20x1 0.909 $55,333.33 $50,298.0020x2 0.826 $59,777.78 $49,376.4420x3 0.751 $50,888.89 $38,217.5620x4 0.683 $46,444.44 $31,721.5620x5 0.621 $45,703.70 $28,382.0020x6 0.564 $43,543.21 $24,558.3720x7 0.513 $42,000.00 $21,546.00

NPV $56,099.93