MGF 405
INSTRUCTOR: S. W. HUH
HW2_chap06
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Chap. 06:
1. B&B Restaurant is considering the purchase of a $9,000 soufflé maker. The soufflé
maker has an economic life of five years and will be fully depreciated by the straightline method. The machine will produce 1,500 soufflés per year, with each costing
$2.30 to make and priced at $4.75. Assume that the discount rate is 14 percent and the
tax rate is 34 percent. Should B&B make the purchase?
2. Franks is looking at a new sausage system with an installed cost of $375,000. This cost
will be depreciated straight-line to zero over the project’s five-year life, at the end of
which the sausage system can be scrapped for $40,000. The sausage system will save
the firm $105,000 per year in pretax operating costs, and the system requires an initial
investment in net working capital of $28,000. If the tax rate is 34 percent and the
discount rate is 10 percent, what is the NPV of this project? (Assume that dNWC will
be fully recovered in the last year of the project.)
3. Howell Petroleum is considering a new project that complements its existing business.
The machine required for the project costs $3.8 million. The marketing department
predicts that sales related to the project will be $2.5 million per year for the next four
years, after which the market will cease to exist. The machine will be depreciated
down to zero over its four-year economic life using the straight-line method. Cost of
goods sold and operating expenses related to the project are predicted to be 25 percent
of sales. Howell also needs to add net working capital of $150,000 immediately. The
additional net working capital will be recovered in full at the end of the project’s life.
The corporate tax rate is 35 percent. The required rate of return for Howell is 16
percent. Should Howell proceed with the project?
4. You are evaluating two different silicon wafer milling machines. The Techron I costs
$215,000, has a three-year life, and has pretax operating costs of $35,000 per year. The
Techron II costs $270,000, has a five-year life, and has pretax operating costs of
$44,000 per year. For both milling machines, use straight-line depreciation to zero
over the project’s life and assume a salvage value of $20,000. If your tax rate is 35
percent and your discount rate is 12 percent, compute the EAC for both machines.
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Which do you prefer? Why? (Assume that each machine will be replaced (forever)
with a new one in the last year of its life.)
5. Massey Machine Shop is considering a four-year project to improve its production
efficiency. Buying a new machine press for $640,000 is estimated to result in
$270,000 in annual pretax cost savings. The press falls in the MACRS five-year class,
and it will have a salvage value at the end of the project of $70,000. The press also
requires an initial investment in spare parts inventory of $20,000, along with an
additional $3,500 in inventory for each succeeding year of the project. If the shop’s tax
rate is 35 percent and its discount rate is 14 percent, should Massey buy and install the
machine press? (Assume that dNWC will be fully recovered in the last year of the
project.)
6. Phillips Industries runs a small manufacturing operation. For this fiscal year, it expects
real net cash flows of $190,000. Phillips is an ongoing operation, but it expects
competitive pressures to erode (decrease) its real net cash flows at 4 percent per year
in perpetuity. The appropriate real discount rate for Phillips is 11 percent. All net cash
flows are received at year-end. What is the present value of the net cash flows from
Phillips’s operations?
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