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13 Apr 2018

1. Suppose you buy an asset for $1,000,000. If it costs $100,000 for shipping and installation, how much is your investment outlay?

2. Suppose you buy an asset for $100,000 that is depreciated for tax purposes over 20 years using straight-line depreciation. Break down

the tax effects upon sale of this asset after five years if the sales

price is: (a) $125,000 (b) $100,000 (c) $75,000 (d) $50,000

3. The Schwab Steel Company is considering two different wire sol-dering machines. Machine 1 has an initial cost of $100,000, costs $20,000 to set up and is expected to be sold for $20,000 after 10 years. Machine 2 has an initial cost of $80,000, costs $30,000 to set up and is expected to be sold for $10,000 after 10 years. Both machines would be depreciated over 10 years using straight-linedepreciation. Schwab has a tax rate of 35%.

(a)

What are the cash flows related to the acquisition of each machine?

(b)

What are the cash flows related to the disposition of each machine?

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Keith Leannon
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13 Apr 2018

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3) Vandalay Industries is trying to choose between two alternative (mutually exclusive) machines. Whichever machine is selected will be utilized for the foreseeable future (in addition, for the foreseeable future, all revenues, costs and expenses are expected to remain unchanged). Machine A costs $2,400,000 and will last (economic life) four years. Variable costs will be 35% of sales, and fixed costs are $180,000 per year. The machine will be depreciated over 3 years, straight line. Sales revenues will be $2,000,000 per year. Machine B costs $3,300,000 and will last (economic) five years. Variable costs will be 30% of sales, and fixed costs are $110,000 per year. The machine will be depreciated over 3 years, straight line. Sales revenues will be $2,000,000 per year. The required return is 10% and the tax rate is 40%. Which machine, if either, should Vandalay Industries select? Be sure to provide quantitative justification for your answer.

Rocky Mountain Chemical Corporation (RMC) is thinking of replacing the packaging machines in its Texas plant. Each packaging machine currently in use has a net book value of $1 million and will continue to be depreciated on a straight-line basis to a net book value of zero over the next 5 years. The plant engineer estimates that the old machines could be used for as many as ten more years. The purchase price for the new machines is $5 million apiece, which would be depreciated over a ten-year period on a straight-line basis to a net book value of $500,000 each. Each new machine is expected to produce a pretx operating savings of $1.5 million per year over the machine it would replace.

RMC estimates that it could sell the old packaging machines for $250,000 each. Installation of each new machine would be expected to cost $600,000 in addition to the purchase price. Of this amount, $500,000 would be capitalized in the same way as the purchase price, and the remaining $100,000 would be expensed immediately. Because the new machines are so much faster than the ones they would replace, the company's average raw materials inventory account would need to be increased by $30,000 for each new machine. Simultaneously, because of trade credit, accounts payable would increase by $10,000. Finally, management believes that even though the new machines would have a nete book value of $500,000 at the end of ten years, it would be possible to sell them for only $300,000, with removal and cleanup cost of $40,000. The changes in working capital (inventory and payables) are fully reverseable at the end of the 10-year life of the machines.

If RMC has a marginal tax rate of 40%, what would be the after-tax incremental expected Initial Investment, annual operating, and terminal value cash flows associated with each new machine? If the project's required return is 12%, what is the project's IRR, MIRR, and NPV?

Warden Co plans to buy a new machine to replace an old one. The cost of the machine, payable immediately, is $1,000,000 and the machine has an expected life of 5 years. The machine will cause networking capital to decline at the start of the first year of operation. At the end of the five years, the machine will be sold for scrap, with the scrap value expected to be 5% of the initial purchase cost of the machine. The old machine was bought 9 years ago for $400,000 and was being depreciated over 10 years . The current market value of the machine is $20,000. Production and sales from the new machine are expected to be 100,000 units per year. Each unit can be sold for $16 per unit and will incur variable costs of $11 per unit. Selling price inflation is expected to be 3% per year and variable cost will exhibit a similar level of inflation. Prior to purchase of the machine, total fixed cost per year were $180,000 but with the new machine total fixed cost is $300,000 per year. Warden Co has an after-tax cost of capital of 11% which it uses as a discount rate in investment appraisal. The company pays profit tax an annual rate an annual rate of 30% per year. Required: a) Calculate the NPV of investing in the new machine and advise whether the investment is financially acceptable b)Calculate the IRR of investing in the new machine and advise whether it is financially acceptable

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