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95.
Phone Home, Inc. is considering a new 4-year expansion project that
requires an initial fixed asset investment of $3 million. The fixed asset will
be depreciated straight-line to zero over its 4-year tax life, after which time
it will have a market value of $225,000. The project requires an initial
investment in net working capital of $330,000, all of which will be recovered
at the end of the project. The project is estimated to generate $2,640,000 in
annual sales, with costs of $1,056,000. The tax rate is 33 percent and the
required return for the project is 15 percent. What is the net present value
for this project?
96.
Dog Up! Franks is looking at a new sausage system with an installed cost of
$397,800. This cost will be depreciated straight-line to zero over the
project's 7-year life, at the end of which the sausage system can be
scrapped for $61,200. The sausage system will save the firm $122,400 per
year in pretax operating costs, and the system requires an initial investment
in net working capital of $28,560. All of the net working capital will be
recovered at the end of the project. The tax rate is 33 percent and the
discount rate is 9 percent. What is the net present value of this project?
97.
Your firm is contemplating the purchase of a new $1,628,000 computer-
based order entry system. The system will be depreciated straight-line to
zero over its 5-year life. It will be worth $156,300 at the end of that time.
You will save $642,500 before taxes per year in order processing costs and
you will be able to reduce working capital by $115,764 (this is a one-time
reduction). The net working capital will return to its original level when the
project ends. The tax rate is 35 percent. What is the internal rate of return
for this project?
98.
A 4-year project has an initial asset investment of $306,600, and initial net
working capital investment of $29,200, and an annual operating cash flow of
-$46,720. The fixed asset is fully depreciated over the life of the project and
has no salvage value. The net working capital will be recovered when the
project ends. The required return is 15 percent. What is the project's
equivalent annual cost, or EAC?
99.
Heer Enterprises needs someone to supply it with 225,000 cartons of
machine screws per year to support its manufacturing needs over the next 7
years, and you've decided to bid on the contract. It will cost you $1,230,000
to install the equipment necessary to start production; you'll depreciate this
cost straight-line to zero over the project's life. You estimate that in 7 years,
this equipment can be salvaged for $75,000. Your fixed production costs will
be $360,000 per year, and your variable production costs should be $13.20
per carton. You also need an initial investment in net working capital of
$112,500, all of which will be recovered when the project ends. Your tax
rate is 32 percent and you require a 13 percent return on your investment.
What bid price per carton should you submit?
100.
Chapman Machine Shop is considering a 4-year project to improve its
production efficiency. Buying a new machine press for $576,000 is
estimated to result in $192,000 in annual pretax cost savings. The press
falls in the MACRS 5-year class, and it will have a salvage value at the end
of the project of $84,000. The press also requires an initial investment in
spare parts inventory of $24,000, along with an additional $3,600 in
inventory for each succeeding year of the project. The inventory will return
to its original level when the project ends. The shop's tax rate is 35 percent
and its discount rate is 11 percent. Should the firm buy and install the
machine press? Why or why not?
101.
Eads Industrial Systems Company (EISC) is trying to decide between two
different conveyor belt systems. System A costs $427,000, has a 6-year life,
and requires $115,000 in pretax annual operating costs. System B costs
$502,000, has an 8-year life, and requires $79,000 in pretax annual
operating costs. Both systems are to be depreciated straight-line to zero
over their lives and will have a zero salvage value. Whichever system is
chosen, it will not be replaced when it wears out. The tax rate is 33 percent
and the discount rate is 24 percent. Which system should the firm choose
and why?
102.
Consider a project to supply 60,800,000 postage stamps to the U.S. Postal
Service for the next 5 years. You have an idle parcel of land available that
cost $760,000 five years ago; if the land were sold today, it would net you
$912,000, aftertax. The land can be sold for $1,500,000 after taxes in 5
years. You will need to install $2,356,000 in new manufacturing plant and
equipment to actually produce the stamps; this plant and equipment will be
depreciated straight-line to zero over the project's 5-year life. The
equipment can be sold for $456,000 at the end of the project. You will also
need $469,000 in initial net working capital for the project, and an additional
investment of $38,000 in every year thereafter. All net working capital will
be recovered when the project ends. Your production costs are 0.38 cents
per stamp, and you have fixed costs of $608,000 per year. Your tax rate is
31 percent and your required return on this project is 11 percent. What bid
price per stamp should you submit?
Essay Questions
103.
In a single sentence, explain how you can determine which cash flows
should be included in the analysis of a project.
104.
What is the formula for the tax-shield approach to OCF? Explain the two key
points the formula illustrates.
105.
What is the primary purpose of computing the equivalent annual costs when
comparing two machines? What is the assumption that is being made about
each machine?
106.
Assume a firm sets its bid price for a project at the minimum level as
computed using the discounted cash flow method. Given this, what do you
know about the net present value and the internal rate of return on the
project as bid?
107.
Can the initial cash flow at time zero for a project ever be a positive value?
If yes, give an example. If no, explain why not.
108.
How can two firms arrive at two different bid prices when bidding for the
same job and given the same bid specifications?
