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Corporate Finance

Corporate Finance

Use the table for the question(s) below.

Glucose Scan Incorporated (GSI) currently sells its latest glucose monitor, the Glucoscan 3000,
to diabetic patients for $129.  GSI plans on lowering their price next year to $99 per unit.  The
cost of goods sold for each Glucoscan unit is $50, and GSI expects to sell 100,000 units over the
next year.

1) Suppose that if GSI drops the price on the Glucoscan 3000 immediately, it can increase sales
over the next year by 30% to 130,000 units.  Also suppose that for each Glucoscan monitor sold,
GSI expects additional sales of $100 per year on glucose testing strips and these strips have a
gross profit margin of 75%.  Considering the increase in the sale of testing strips, the incremental
impact of this price drop on the firms EBIT is closest to:
A) A decline of 1.5 million
B) A decline of 0.7 million
C) An increase of 0.7 million
D) An increase of 1.5 million
Answer:  C
Explanation:  C) Without Price Cut
Monitor sales = 100,000 × ($129 – $50) = $7,900,000
Strip sales = 100,000 × ($100 – $25) = $7,500,000

Total EBIT = 7,900,000 + 7,500,000 = 15,400,000

With Price Cut
Monitor sales = 130,000 × ($99 – $50) = $6,370.000
Strip sales = 130,000 × ($100 – $25) = $9,750,000

Total EBIT = 6,370,000 + 9,750,000 =  16,120,000

Incremental = 16,120,000 –  15,400,000  =  720,000

2) You are considering adding a microbrewery on to one of your firm’s existing restaurants.  This
will entail an investment of $40,000 in new equipment.  This equipment will be depreciated
straight line over five years.  If your firm’s marginal corporate tax rate is 35%, then what is the
value of the microbrewery’s depreciation tax shield in the first year of operation?
A) $2,800
B) $14,000
C) $5,200
D) $26,000
Answer:  A
Explanation:  A) First figure out the straight line depreciation.

Use the table for the question(s) below.
Shepard Industries is evaluating a proposal to expand its current distribution facilities.
Management has projected the project will produce the following cash flows for the first two
years (in millions).

Year  1  2
Revenues  1200  1400
Operating Expense  450  525
Depreciation  240  280
Increase in working
capital  60  70
Capital expenditures  300  350
Marginal corporate tax
rate  30%  30%

3) The incremental EBIT for Shepard Industries in year one is closest to:
A) $360
B) $750
C) $595
D) $510
Answer:  D
Explanation:  D)
Revenues  1200  1400
– Expenses  450  525
– Depreciation  240  280
= EBIT  510  595

4) The incremental unlevered net income Shepard Industries in year two is closest to:
A) $355
B) $415
C) $600
D) $510
Answer:  B
Explanation:  B)
Revenues  1200  1400
– Expenses  450  525
– Depreciation  240  280
= EBIT  510  595
– Taxes (30%)  153  178.5
Incremental Net Income  357  416.5

5) The depreciation tax shield for Shepard Industries project in year two is closest to:
A) $84
B) $196
C) $72
D) $96
Answer:  A
Explanation:  A) $280 × .30 = $84

6) The free cash flow from Shepard Industries project in year one is closest to:
A) $240
B) $300
C) -$5
D) $390
Answer:  A
Explanation:  A)
Free Cash Flow
Revenues  1200  1400
– Expenses  450  525
– Depreciation  240  280
= EBIT  510  595
– Taxes (30%)  153  178.5
Incremental Net Income  357  416.5
+ Depreciation  240  280
– Capital expenditures  300  350
– Change in NWC  60  70
Free Cash Flow  237  276.5

Corporate Finance

Use the table for the question(s) below.

Glucose Scan Incorporated (GSI) currently sells its latest glucose monitor, the Glucoscan 3000,
to diabetic patients for $129.  GSI plans on lowering their price next year to $99 per unit.  The
cost of goods sold for each Glucoscan unit is $50, and GSI expects to sell 100,000 units over the
next year.

1) Suppose that if GSI drops the price on the Glucoscan 3000 immediately, it can increase sales
over the next year by 30% to 130,000 units.  Also suppose that for each Glucoscan monitor sold,
GSI expects additional sales of $100 per year on glucose testing strips and these strips have a
gross profit margin of 75%.  Considering the increase in the sale of testing strips, the incremental
impact of this price drop on the firms EBIT is closest to:
A) A decline of 1.5 million
B) A decline of 0.7 million
C) An increase of 0.7 million
D) An increase of 1.5 million
Answer:  C
Explanation:  C) Without Price Cut
Monitor sales = 100,000 × ($129 – $50) = $7,900,000
Strip sales = 100,000 × ($100 – $25) = $7,500,000

Total EBIT = 7,900,000 + 7,500,000 = 15,400,000

With Price Cut
Monitor sales = 130,000 × ($99 – $50) = $6,370.000
Strip sales = 130,000 × ($100 – $25) = $9,750,000

Total EBIT = 6,370,000 + 9,750,000 =  16,120,000

Incremental = 16,120,000 –  15,400,000  =  720,000

2) You are considering adding a microbrewery on to one of your firm’s existing restaurants.  This
will entail an investment of $40,000 in new equipment.  This equipment will be depreciated
straight line over five years.  If your firm’s marginal corporate tax rate is 35%, then what is the
value of the microbrewery’s depreciation tax shield in the first year of operation?
A) $2,800
B) $14,000
C) $5,200
D) $26,000
Answer:  A
Explanation:  A) First figure out the straight line depreciation.

Use the table for the question(s) below.
Shepard Industries is evaluating a proposal to expand its current distribution facilities.
Management has projected the project will produce the following cash flows for the first two
years (in millions).

Year  1  2
Revenues  1200  1400
Operating Expense  450  525
Depreciation  240  280
Increase in working
capital  60  70
Capital expenditures  300  350
Marginal corporate tax
rate  30%  30%

3) The incremental EBIT for Shepard Industries in year one is closest to:
A) $360
B) $750
C) $595
D) $510
Answer:  D
Explanation:  D)
Revenues  1200  1400
– Expenses  450  525
– Depreciation  240  280
= EBIT  510  595

4) The incremental unlevered net income Shepard Industries in year two is closest to:
A) $355
B) $415
C) $600
D) $510
Answer:  B
Explanation:  B)
Revenues  1200  1400
– Expenses  450  525
– Depreciation  240  280
= EBIT  510  595
– Taxes (30%)  153  178.5
Incremental Net Income  357  416.5

5) The depreciation tax shield for Shepard Industries project in year two is closest to:
A) $84
B) $196
C) $72
D) $96
Answer:  A
Explanation:  A) $280 × .30 = $84

6) The free cash flow from Shepard Industries project in year one is closest to:
A) $240
B) $300
C) -$5
D) $390
Answer:  A
Explanation:  A)
Free Cash Flow
Revenues  1200  1400
– Expenses  450  525
– Depreciation  240  280
= EBIT  510  595
– Taxes (30%)  153  178.5
Incremental Net Income  357  416.5
+ Depreciation  240  280
– Capital expenditures  300  350
– Change in NWC  60  70
Free Cash Flow  237  276.5


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