1.
MTM Inc., is considering the purchase of a new machine which will reduce
manufacturing costs by $5,000 annually. MTM will use the straight-line method to
depreciate the machine, and it expects to sell the machine at the end of its 5 year life
for $10,000. The firm expects to be able to reduce working capital by $15,000 when
the machine is installed. The firm's marginal tax rate is 34% and it uses a 12% cost
of capital to evaluate projects of this nature. If the machine costs $60,000, what is the
NPV of the project's cash flows? [-$23,685]
2.
After a disastrous ski season last year, Valley, Inc., is considering the installation of
a snow machine. The machine has an invoice price of $100,000, and it will cost
$10,000 to install the machine. It is estimated that the machine will increase
revenues by $25,303 annually, although operating expenses other than depreciation
will also increase by $5,000. The machine will be depreciated on a straight-line
basis over its useful life (10 years) to a zero salvage value. If the tax rate on ordinary
income is 34%, what is the project's IRR (approximately)? [IRR = 9%]
3.
As the capital budgeting director for Harding Industries, Inc., you are evaluating the
construction of a new plant. The plant has a net cost of $4.921 million in year 0, and
it will provide net cash inflows of $1 million in year 1, $1.5 million in year 2, and $2
million in years 3 through 5. As a first approximation, you may assume that all cash
flows occur at year-end. What is the plant's approximate IRR? [IRR = 19%]
4.
Ferrari of Ohio is considering the purchase of land and the construction of a new
plant. The land, which would be bought immediately, has a cost of $100,000 and
the building, which would be erected at the end of the year, would cost $500,000. It
is estimated that the firm's after-tax cash flow will be increased by $100,000
beginning at the end of the second year and this incremental flow would increase at
a 10% rate annually over the next 10 years. What would be the payback period
(approximately)? [6 years]
5.
Two projects being considered are mutually exclusive and have the following
projected cash flows:
Year
0
1
2
3
4
5
Project A
-$50,000
15,625
15,625
15,625
15,625
15,625
Project B
-$50,000
0
0
0
0
99,500
Beyond what level of required return (approximately) would you change your
selection? [12%]
6.
Two projects being considered by MTX are mutually exclusive and have the
following projected cash flows:
Year
0
1
2
3
Project A
-$100,000
39,550
39,550
39,550
Project B
-$100,000
0
0
133,500
Based ONLY on the information given, what is the IRR for the two projects?
Which would you chose? What are the NPV’s of the two projects if the cost of
capital is 7%? [IRR A = 9% IRR B = 10% B Has Higher Irr; NPV Project A =
$3,791.70, NPV Project B = $8,975.77]
7.
What are the respective IRRs for Projects A, B, C, and D?
= 13%: IRR C = 24% : IRR D = 14%]
Project
Cost
A
$10,000
B
5,000
C
12,000
D
3,000
8.
Annual
Cash Inflows
$11,700
2,997
6,057
1,030
Life
(years)
1
2
3
4
[IRR A = 17% : IRR B
IRR
?
?
?
?
As the DCB for Midterm INC., you are evaluating two mutually exclusive projects
with the following net cash flows:
Year
0
1
2
3
4
Project X
-$100,000
50,000
40,000
30,000
10,000
Project Z
-$100,000
10,000
30,000
50,000
60,000
If Midterm's cost of capital is 15%, which of the machines (if either) would the firm
accept? [NPV X = -$832.97 NPV Z = -$1,439.03 BOTH NEGATIVE]
9.
Two projects being considered are mutually exclusive and have the following
projected cash flows:
Year
0
1
2
3
4
5
Project A
-$50,000
15,625
15,625
15,625
15,625
15,625
Project B
-$150,000
0
0
0
0
299,500
Calculate the crossover rate. Below this rate, which project do you choose?
Above? [14.35%, below choose B, above chose A]
10. Tyler Products, Inc., requires a new machine to produce a part for a heat generator.
Two companies have submitted bids, and you have been assigned the task of
choosing one of the machines. Cash flow analysis indicates the following:
Year
0
1
2
3
4
Machine A
-$1,000
0
0
0
1,938
Machine B
-$1,000
417
417
417
417
If a graph of net present values were developed for these two investments, at what
discount rate would the values cross? [10.09%]
11. Consider the following set of investment alternatives.
A.
B.
C.
D.
E.
NPV
$15
$25
$10
$ 8
$45
IRR
18%
29%
15%
12%
25%
PAYBACK
6.0 YRS.
2.5 YRS.
3 3 YRS.
4.0 YRS.
3.0 YRS.
INITIAL INVESTMENT
$150
$ 85
$160
$ 45
$365
Assuming the capital budget is fixed at $400, which projects should be accepted?
[Projects A, B, And C] (Note that this requires some thinking. You are trying to
maximize the total NPV and can only invest $400. Traditional methods may not
work here.)
12. Red and Blue, Inc., is considering replacing its old bottling machine with a new,
more efficient machine. Relevant data for this decision are given below:
OLD
NEW
INITIAL COST
$ 60,000
$ 80,000
CURRENT AGE
20 YRS
0
REMAINING USEFUL LIFE 10 YRS
10 YRS
SALVAGE VALUE AT END $
0
$ 10,000
MAINTENANCE COSTS
$ 15,000/YR $ 3,000/YR
REQUIRED INCREASE IN
WORKING CAPITAL
$ 2,000
$ 6,000
CURRENT MARKET VALUE $ 25,000
$ 80,000
Assuming a 34% tax rate, straight-line depreciation, and a 6% required rate of
return, what is the NPV of this replacement decision? [$17,921.56]
13. Missouri Metals, Inc. is considering the replacement of its existing lathe, which cost
$200,000 at the time of purchase five years ago, and which now has a remaining life
of five years with no salvage value. It can be sold currently for $100,000. A new,
more operationally efficient lathe costs $300,000 and has a useful life of five years
with a salvage value of $50,000. It is expected to reduce operating costs by $66,000
annually. The firm's required rate of return for replacement decisions is 12%.
Assume straight-line depreciation and a tax rate of 34 percent. What is the net
present value of this capital budgeting decision? [$22,164.05]
14. Davis & Associates is considering the purchase of a new pizza oven. The original
cost of the old oven was $30,000. The machine is now 5 years old and has a current
market value of $5,000. The oven is being depreciated over a 10 year life toward a
zero estimated salvage value on a straight line basis. Management is contemplating
the purchase of a new oven whose cost is $25,000 and whose estimated salvage
value is zero. Expected cash savings from the new oven are $7,000 a year (before
tax). Depreciation is on a straight line basis over a 5 year life, and the cost of capital
is 10%. Assume a 34% tax rate. What is the net present value of the new machine?
[$3,491.17]
15. Heel & Sole, Inc., is considering the purchase of a new leather-cutting machine to
replace an existing machine that has a book value of $3,000 and can be sold for
$1,500. The estimated salvage value of the old machine in 4 years is zero. The new
machine will reduce costs (before tax) by $7,000 per year; that is, $7,000 cash
savings over the old machine. The new machine has a 4 year life, costs $14,000,
and can be sold for an expected $2,000 at the end of the fourth year (it will be
depreciated to a book value of $2,000). Assuming straight line depreciation for both
machines, a 34% tax rate, and a cost of capital of 16%, find the NPV. [$4,182.91]
16. DC, Inc., has a stamping machine which is 5 years old and which is expected to last
another 10 years. It has a book value of $100,000 and is being depreciated by the
straight line method to zero. Allstate Industries has demonstrated a new machine
with an expected useful life of 10 years (scrap value $50,000) that should save DC
$38,000 a year in labor and maintenance costs. The firm's tax rate is 34%, and the
new machine will cost $200,000. The market value of the old machine is $10,000
and a $10,000 increase in working capital will be needed to support the new
machine. If DC's cost of capital is 10%, should the replacement be made?
[$18,282.39]
17. Stork Company is considering the purchase of a new machine to replace an existing
one. The old machine was purchased 5 years ago at a cost of $50,000 and is being
depreciated on a straight line basis to a zero salvage value 5 years from today. The
current market value of the old machine is $15,000. The new machine has an
estimated life of 5 years, costs $75,000, and has an estimated zero salvage value. It
is expected to generate cash savings (before taxes) of $25,000 per year. What is the
NPV of the proposed purchase if the tax rate is 34% and the cost of capital is 11%?
[$16,948]
18. You have been asked by the CEO of Gadsden Co. to evaluate the proposed
acquisition of a new machine. The machine's price is $50,000, and it will cost
$10,000 to transport and install. It will be depreciated by the straight line method
over its 5 year useful life to a $10,000 salvage value. The machine will increase
revenues by $10,000 per year, and it will decrease operating costs by $20,000 per
year. Also, the machine will allow the firm to reduce inventories by $5,000. If the
firm's cost of capital is 12%, and its marginal tax rate is 34%, what is the new
machine's NPV? [$29,016.69]