CHAPTER 10 B-187
20. If we are trying to decide between two projects that will not be replaced when they wear out, the proper
capital budgeting method to use is NPV. Both projects only have costs associated with them, not sales,
so we will use these to calculate the NPV of each project. Using the tax shield approach to calculate the
OCF, the NPV of System A is:
OCFA = –$110,000(1 – 0.34) + 0.34($430,000/4)
OCFA = –$36,050
NPVA = –$430,000 – $36,050(PVIFA11%,4)
NPVA = –$541,843.17
21. If the equipment will be replaced at the end of its useful life, the correct capital budgeting technique is
EAC. Using the NPVs we calculated in the previous problem, the EAC for each system is:
EACA = –$541,843.17 / (PVIFA11%,4)
EACA = –$174,650.33
22. To find the bid price, we need to calculate all other cash flows for the project, and then solve for the bid
price. The aftertax salvage value of the equipment is:
After-tax salvage value = $540,000(1 – 0.34)
After-tax salvage value = $356,400
Now we can solve for the necessary OCF that will give the project a zero NPV. The current aftertax
value of the land is an opportunity cost, but we also need to include the aftertax value of the land in five
years since we can sell the land at that time. The equation for the NPV of the project is:
NPV = 0 = –$4,100,000 – 2,700,000 – 600,000 + OCF(PVIFA12%,5) – $50,000(PVIFA12%,4)
+ {($356,400 + 600,000 + 4(50,000) + 3,200,000] / 1.125}