🏷️ LIMITED TIME OFFER: GET 20% OFF GRADE+ YEARLY SUBSCRIPTION →
Log in
Finance
1
answer
0
watching
128
views

In November of 2006, Toyota completed the building of its truck assembly plant in San Antonio, Texas. Unfortunately, in the rush to meet construction deadlines, Toyota instructed the general contractor to not install air conditioning (A/C) in the main facility. But now the time has come for Toyota to finish the facility with the installation of A/C. Toyota's contractor has developed two alternative plans (they are mutually exclusive) for the company to consider:

Plan 1: This A/C investment would require an initial outlay of $600,000 with the following end of year net cash flows: Year 1: -$50,000; Year 2: -$50,000; Year 3: -$50,000; Year 4: -$50,000, Year 5: -$50,000.

Plan 2: This alternative plan would require a smaller initial outlay but higher yearly operating costs. The initial outlay would be $100,000 and end of year net cash flows are estimated to be: Year 1: -$175,000; Year 2: -$175,000; Year 3: -$175,000, Year 4: -$175,000; Year 5: -$175,000.

Question 1: Calculate the NPV for each plan. Assume that Toyota's WACC is 7%. Use a financial calculator to answer this question and show your keystrokes. Check figures for Plan 1: Keystrokes using the HP12C NPV keys are CF0 = -$600,000, CFj = -$50,000, Nj = 5, i = 7, so NPV for plan 1 is -$805,009.87; or using TVM keys (n=5, i=7, PV=?, PMT=-$50,000, FV=0) = -$205,009.87 plus -$600,000 = -$805,009.87.

Question 2: For mutually exclusive projects, normally the rule is to accept only the project or plan with the highest positive NPV. However, Toyota is faced with a mandatory decision to accept either plan 1 or 2, neither of which generates positive net cash flows. Which plan should Toyota accept? Explain why.

Question 3: Explain why the IRR of either plan cannot be determined.

Watch
1
answer
0
watching
128
views

For unlimited access to Homework Help, a Homework+ subscription is required.

Elin Hessel
Elin HesselLv2
28 Sep 2019

Unlock all answers

Get 1 free homework help answer.
Already have an account? Log in
Share

Related questions

You are the head of finance department in XYZ Company. You are considering adding a new machine to your production facility. The new machine’s base price is $10,900.00, and it would cost another $1,970.00 to install it. The machine falls into the MACRS 3-year class (the applicable MACRS depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%), and it would be sold after three years for $2,150.00. The machine would require an increase in net working capital (inventory) of $680.00. The new machine would not change revenues, but it is expected to save the firm $33,085.00 per year in before-tax operating costs, mainly labor. XYZ's marginal tax rate is 32.00%.

1. If the project's cost of capital is 14.20%, what is the NPV of the project?

2. What is the initial cash outlay? (3 pts.)
3. What are the free cash flow for year 1? (3 pts)
4. What is the additional Year-3 cash flow (i.e, the after-tax salvage and the return of working capital – also called terminal value)?

EXPLAIN ALL ANSWERS AND SHOW ALL WORK

You have been asked by the president of Ellis Construction Company, headquartered in Toledo, to evaluate the proposed acquisition of a new earthmover. The mover’s basic price is $50,000, and it will cost another $10,000 to modify it for special use by Ellis Construction. Assume that the earthmover falls into the MACRS 3-year class. (See Table 10A.2 at the end of Chapter 10 for MACRS recovery allowance percentages.) It will be sold after three years for $20,000, and it will require an increase in net working capital (spare parts inventory) of $2,000. The earthmover purchase will have no effect on revenues, but it is expected to save Elli $20,000 per year in before-tax operating costs, mainly labor. Ellis’s marginal tax rate is 40 percent.

a. What is the company’s net initial investment outlay if it acquires the earthmover? (That is,
what is the Year 0 net cash flow?)

b. What are the incremental operating cash flows in Years 1, 2, and 3?

c. What is the terminal cash flow in Year 3?

d. If the project’s required rate of return is 10 percent, should the earthmover be purchased?

12-2: Analysis of an Expansion Project Problem 12-9 New project analysis You must evaluate a proposal to buy a new milling machine. The base price is $106,000, and shipping and installation costs would add another $16,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $47,700. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $6,500 increase in net operating working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline by $50,000 per year. The marginal tax rate is 35%, and the WACC is 10%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine.

A: How should the $5,000 spent last year be handled?

1. Only the tax effect of the research expenses should be included in the analysis.

2. Last year's expenditure should be treated as a terminal cash flow and dealt with at the end of the project's life. Hence, it should not be included in the initial investment outlay.

3. Last year's expenditure is considered an opportunity cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.

4. Last year's expenditure is considered a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.

5. The cost of research is an incremental cash flow and should be included in the analysis.

B: What is the initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year 0 project cash flow? Round your answer to the nearest cent.

C: What are the project's annual cash flows during Years 1, 2, and 3? Round your answer to the nearest cent.

Year 1: ?

Year 2: ?

Year 3: ?

D: Should the machine be purchased?

Weekly leaderboard

Home
Homework Help 3,900,000
Finance 370,000
Start filling in the gaps now
Log in