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b. After-tax operating cash flows will increase by $10,000.
c. After–tax operating cash flows will decrease by $25,000.
d. After–tax operating cash flows will decrease by $10,000.
e. Because depreciation is a non–cash expense, operating cash flows should not change.
90. Topsider 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 old machine is being depreciated on a straight–line basis, and
its estimated salvage value 3 years from now is zero. The new machine will reduce costs (before taxes) by $7,000
per year. The new machine has a 3-year life, it costs $14,000, and it can be sold for an expected $2,000 at the end
of the third year. The new machine would be depreciated over its 3-year life using the MACRS method. Assuming
a 40 percent tax rate and a required rate of return of 16 percent, find the new machine’s NPV.
a. −$2,822
b. $1,658
c. $4,560
d. $15,374
e. $9,821
91. Meals on Wings Inc. supplies prepared meals for corporate aircraft (as opposed to public commercial airlines), and
it needs to purchase new broilers. If the broilers are purchased, they will replace old broilers purchased 10 years
ago for $105,000 and which are being depreciated on a straight line basis to a zero salvage value (15-year
depreciable life). The old broilers can be sold for $60,000. The new broilers will cost $200,000 installed and will be
depreciated using MACRS over their 5-year class life; they will be sold at their book value at the end of the 5th
year. The firm expects to increase its revenues by $18,000 per year if the new broilers are purchased, but cash
expenses will also increase by $2,500 per year. If the firm’s required rate of return is 10 percent and its tax rate is
34 percent, what is the NPV of the broilers?
a. −$61,019
b. $17,972
c. $28,451
d. −$44,553
e. $5,021
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92. Mom’s Cookies Inc. is considering the purchase of a new cookie oven. The original cost of the old oven was
$30,000; it is now 5 years old, and it has a current market value of $13,333.33. The old oven is being depreciated
over a 10–year life towards a zero estimated salvage value on a straight line basis, resulting in a current book value
of $15,000 and an annual depreciation expense of $3,000. The old oven can be used for 6 more years but has no
market value after its depreciable life is over. Management is contemplating the purchase of a new oven whose
cost is $25,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new oven
are $4,000 a year over its full MACRS depreciable life. Depreciation is computed using MACRS over a 5-year life,
and the required rate of return is 10 percent. Assume a 40 percent tax rate. What is the net present value of the
new oven?
a. −$2,418
b. −$1,731
c. $1,568
d. $163
e. $1,731
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93. Tech Engineering 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 $20,000, and it is being depreciated on a straight line basis to a
zero salvage value over a 10-year life. The current market value of the old machine is $14,000. The new machine,
which falls into the MACRS 5-year class, has an estimated life of 5 years, it costs $30,000, and Tech plans to sell
the machine at the end of the 5th year for $1,000. The new machine is expected to generate before–tax cash
savings of $3,000 per year. The company’s tax rate is 40 percent. What is the IRR of the proposed project?
a. 4.1%
b. 2.2%
c. 0.0%
d. −1.5%
e. −3.3%
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94. California Mining is evaluating the introduction of a new ore production process. Two alternatives are available.
Production Process A has an initial cost of $25,000, a 4–year life, and a $5,000 net salvage value, and the use of
Process A will increase net cash flow by $13,000 per year for each of the 4 years that the equipment is in use.
Production Process B also requires an initial investment of $25,000, will also last 4 years, and its expected net
salvage value is zero, but Process B will increase net cash flow by $15,247 per year. Management believes that a
risk–adjusted discount rate of 12 percent should be used for Process A. If California Mining is to be indifferent
between the two processes, what risk-adjusted discount rate must be used to evaluate B?
a. 8%
b. 10%
c. 12%
d. 14%
e. 16%
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95. Refer to Exhibit 10–1. What is the initial investment outlay for the truck? (That is, what is the Year 0 net cash
flow?)
a. −$50,000
b. −$52,600
c. −$55,800
d. −$62,000
e. −$65,000
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96. Refer to Exhibit 10–1. What is the incremental operating cash flow in Year 1?
a. $17,820
b. $18,254
c. $19,920
d. $20,121
e. $21,737
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97. Refer to Exhibit 10–1. What is the terminal (nonoperating) cash flow at the end of Year 3?
a. $10,000
b. $12,000
c. $15,680
d. $16,000
e. $18,000
98. Refer to Exhibit 10–1. The truck’s required rate of return is 10 percent. What is its NPV?
a. −$1,547
b. −$562
c. $0
d. $562
e. $1,034
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99. Your company must ensure the safety of its work force. Two plans are being considered for the next 10 years: (1)
Install a high electrified fence around the property at a cost of $100,000. Maintenance and electricity would then
cost $5,000 per year over the 10-year life of the fence. (2) Hire security guards at a cost of $25,000 paid at the end
of each year. Because the company plans to build new headquarters with a “state of the art” security system in 10
years, the plan will only be in effect until that time. Your company’s required rate of return is 15 percent for
average projects, and that rate is normally adjusted up or down by 2 percentage points for high– and low-risk
projects. Plan 1 is considered to be of low risk because its costs can be predicted quite accurately. Plan B, on the
other hand, is a high–risk project because of the difficulty of predicting wage rates. What is the proper PV of costs
for the better project?
a. −$104,266.20
b. −$116,465.09
c. −$123,293.02
d. −$127,131.22
e. −$135,656.09
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100. Mid-State Electric Company must clean up the water released from its generating plant. The company’s required
rate of return is 10 percent for average projects, and that rate is normally adjusted up or down by 2 percentage
points for high- and low-risk projects. Clean–up Plan A, which is of average risk, has an initial cost of −$1,000 at
time 0, and its operating cost will be −$100 per year for its 10-year life. Plan B, which is a high-risk project, has an
initial cost of −$300, and its annual operating cost over Years 1 to 10 will be −$200. What is the proper PV of costs
for the better project?
a. −$1,430.04
b. −$1,525.88
c. −$1,614.46
d. −$1,642.02
e. −$1,728.19
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101. Your company is considering a machine that will cost $1,000 at Time 0 and which can be sold after 3 years for
$100. To operate the machine, $200 must be invested at Time 0 in inventories; these funds will be recovered when
the machine is retired at the end of Year 3. The machine will produce sales revenues of $900/year for 3 years;
variable operating costs (excluding depreciation) will be 50 percent of sales. Operating cash inflows will begin 1
year from today (at Time 1). The machine will have depreciation expenses of $500, $300, and $200 in Years 1, 2,
and 3, respectively. The company has a 40 percent tax rate, enough taxable income from other assets to enable it to
get a tax refund from this project if the project’s income is negative, and a 10 percent required rate of return.
Inflation is zero. What is the project’s NPV?
a. $6.24
b. $7.89
c. $8.87
d. $9.15
e. $10.41
102. Your company is considering a machine which will cost $50,000 at Time 0 and which can be sold after 3 years for
$10,000. $12,000 must be invested at Time 0 in inventories and receivables; these funds will be recovered when the
operation is closed at the end of Year 3. The facility will produce sales revenues of $50,000/year for 3 years;
variable operating costs (excluding depreciation) will be 40 percent of sales. No fixed costs will be incurred.
Operating cash inflows will begin 1 year from today (at t = 1). By an act of Congress, the machine will have
depreciation expenses of $40,000, $5,000, and $5,000 in Years 1, 2, and 3 respectively. The company has a 40
percent tax rate, enough taxable income from other assets to enable it to get a tax refund on this project if the
project’s income is negative, and a 15 percent required rate of return. Inflation is zero. What is the project‘s NPV?
a. $7,673.71
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b. $12,851.75
c. $17,436.84
d. $24,989.67
e. $32,784.25
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103. After a long drought, the manager of Long Branch Farm is considering the installation of an irrigation system which
will cost $100,000. It is estimated that the irrigation system will increase revenues by $20,500 annually, although
operating expenses other than depreciation will also increase by $5,000. The system will be depreciated using
MACRS over its depreciable life (5 years) to a zero salvage value. If the tax rate on ordinary income is 40 percent,
what is the project’s IRR?
a. 12.6%
b. −1.3%
c. 13.0%
d. 10.2%
e. −4.8%
11) Return of NWC
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