1. The cash flows from two capital expenditure projects follow. The discount rate is 10%. Project A Initial cost: $(10,000) Project B Initial cost: $(10,000);
Year 1- Project A: 6,000 Project B: 2,000;
Year 2- Project A: 5,000 Project B: 4,000;
Year 3- Project A: 1,000 Project B: 8,000;
Year 4-Project A: 0 Project B: 6,000;
a) What are the payback periods for both projects?
b) What is the NPV for both projects?
c) What are the drawbacks from using payback as a method for selecting projects?
2. Community Drycleaning would like to purchase a new machine for cleaning large quilts and comforters. The current cleaning operation on quilts and comforters is done by hand. The new machine would cost $12,500. The estimated service life is 12 years, at which time it is estimated that the machine could be sold for $500.
The company estimates that it would cost $700 per year to operate the machine. The current cost of manual cleaning is $3,000 per year. In addition to reducing costs, the new machine would increase the drycleaner's ability to clean quilts and comforters by 600 per year. The company realizes a net contribution margin after tax effects of $1.50 per quilt or comforter. A 10% rate of return is required on all investments. Community expects its tax rate to be 30%.
A. What are the annual net cash inflows that would be realized from the new machine?
B. Compute the net present value of the investment (round to the nearest dollar). Use straight-line depreciation based on the machine's estimated service life. Would you recommend that the machine be purchased? Explain your answer.
3. Smith Electronics manufactures portable CD players. Lillian Perez, the VP of operations at Smith Electronics, is considering a major capital investment decision. It would cost $2,500,000 to put new, highly automated machines in the factory. The equipment would last about 15 years and would have no salvage value at the end of that period. The equipment will replace 10 workers, saving Smith $300,000 per year in direct labor. Operation and maintenance costs on the machines are expected to cost $100,000 per year. The automated equipment is expected to improve quality. Smith's main competitors are installing similar equipment. If Smith installs the equipment, its revenues are expected to remain steady. If Smith chooses not to install new equipment, its contribution margins expected to fall by $200,000 per year as a result of lower quality compared to its competitors. Smith's discount rate is 10% and its tax rate is 30%.
A. How much is Smith expected to save each year if it installs the equipment (including tax effects)?
B. How much will Smith lose each year if it does not install the equipment (including tax effects)?
C. Explain how you would analyze this problem in order to determine if Smith should purchase the new machines.
D. Should Smith purchase the new machines?
E. Assume that programming and maintenance costs turn out to be much higher than Lillian's estimates. However, despite the fact that the automation equipment increased costs, Lillian still wants to continue with the project. Explain why Lillian might not want to scrap the equipment.
4. A phone company with a discount rate of 8% is considering two investments.
Residential Service Commercial Service
Initial Cost $(50,000) $(100,000)
Year 1 20,000 50,000
Year 2 20,000 50,000
Year 3 20,000 50,000
A. Calculate the NPV for both services.
B. If the phone company can provide only one service currently, which project should it choose?
C. If this is a regulated service industry, explain why the phone company may have to invest in the residential service."