Assignment
I. Payback comparisons Nova Products has a 5-year maximum acceptable payback period. The firm is considering the purchase of a new machine and must choose between two alternative ones. The first machine requires an initial investment of $14,000 and generates annual after-tax cash inflows of $3,000 for each of the next 7 years. The second machine requires an initial investment of $21,000 and provides an annual cash inflow after taxes of $4,000 for 20 years.
a. Determine thepayback periodfor each machine.
b. Comment on the acceptability of the machines, assuming that they are independent projects.
c. Which machine should the firm accept? Why?
d. Do the machines in this problem illustrate any of the weaknesses of using payback? Discuss.
II. Net present value: Independent projectsUsing a 14% cost of capital, calculate thenet present valuefor each of the independent projects shown in the following table, and indicate whether each is acceptable.
|
Project A
|
Project B
|
Project C
|
Project D
|
Project E
|
|
Initial investment (CF0)
|
$26,000
|
$500,000
|
$170,000
|
$950,000
|
$80,000
|
|
Year (t)
|
Cash inflows (CFt)
|
|
1
|
$4,000
|
$100,000
|
$20,000
|
$230,000
|
$ 0
|
|
2
|
4,000
|
120,000
|
19,000
|
230,000
|
0
|
|
3
|
4,000
|
140,000
|
18,000
|
230,000
|
0
|
|
4
|
4,000
|
160,000
|
17,000
|
230,000
|
20,000
|
|
5
|
4,000
|
180,000
|
16,000
|
230,000
|
30,000
|
|
6
|
4,000
|
200,000
|
15,000
|
230,000
|
0
|
|
7
|
4,000
|
|
14,000
|
230,000
|
50,000
|
|
8
|
4,000
|
|
13,000
|
230,000
|
60,000
|
|
9
|
4,000
|
|
12,000
|
|
70,000
|
|
10
|
4,000
|
|
11,000
|
|
|
III. NPV: Mutually exclusive projects Hook Industries is considering the replacement of one of its old drill presses. Three alternative replacement presses are under consideration. The relevant cash flows associated with each are shown in the following table. The firm's cost of capital is 15%.
|
Press A
|
Press B
|
Press C
|
|
Initial investment (CF0)
|
$85,000
|
$60,000
|
$130,000
|
|
Year (t)
|
Cash inflows (CFt)
|
|
1
|
$18,000
|
$12,000
|
$50,000
|
|
2
|
18,000
|
14,000
|
30,000
|
|
3
|
18,000
|
16,000
|
20,000
|
|
4
|
18,000
|
18,000
|
20,000
|
|
5
|
18,000
|
20,000
|
20,000
|
|
6
|
18,000
|
25,000
|
30,000
|
|
7
|
18,000
|
-
|
40,000
|
|
8
|
18,000
|
-
|
50,000
|
a.Calculate thenet present value (NPV)of each press.
b.Using NPV, evaluate the acceptability of each press.
c.Rank the presses from best to worst using NPV.
d.Calculate theprofitability index (PI)for each press.
e.Rank the presses from best to worst usingPI.
III. Internal rate of returnFor each of the projects shown in the following table, calculate theinternal rate of return (IRR). Then indicate, for each project, the maximum cost of capital that the firm could have and still find the IRR acceptable.
|
Project A
|
Project B
|
Project C
|
Project D
|
|
Initial investment (CF0)
|
$90,000
|
$490,000
|
$20,000
|
$240,000
|
|
Year (t)
|
|
Cash inflows (CFt)
|
|
|
1
|
$20,000
|
$150,000
|
$7,500
|
$120,000
|
|
2
|
25,000
|
150,000
|
7,500
|
100,000
|
|
3
|
30,000
|
150,000
|
7,500
|
80,000
|
|
4
|
35,000
|
150,000
|
7,500
|
60,000
|
|
5
|
40,000
|
-
|
7,500
|
-
|
IV. All techniques, conflicting rankings Nicholson Roofing Materials, Inc., is considering two mutually exclusive projects, each with an initial investment of $150,000. The company's board of directors has set a maximum 4-year payback requirement and has set its cost of capital at 9%. The cash inflows associated with the two projects are shown in the following table.
|
Cash inflows (CFt)
|
|
Year
|
Project A
|
Project B
|
|
1
|
$45,000
|
$75,000
|
|
2
|
45,000
|
60,000
|
|
3
|
45,000
|
30,000
|
|
4
|
45,000
|
30,000
|
|
5
|
45,000
|
30,000
|
|
6
|
45,000
|
30,000
|
a.Calculate thepayback periodfor each project.
b.Calculate theNPVof each project at 0%.
c.Calculate theNPVof each project at 9%.
d.Derive theIRRof each project.
e.Rank the projects by each of the techniques used. Make and justify a recommendation.
f.Go back one more time and calculate the NPV of each project using a cost of capital of 12%. Does the ranking of the two projects change compared to your answer in parte?Why?
V. Sunk costs and opportunity costs Masters Golf Products, Inc., spent 3 years and $1,000,000 to develop its new line of club heads to replace a line that is becoming obsolete. To begin manufacturing them, the company will have to invest $1,800,000 in new equipment. The new clubs are expected to generate an increase in operating cash inflows of $750,000 per year for the next 10 years. The company has determined that the existing line could be sold to a competitor for $250,000.
a.How should the $1,000,000 in development costs be classified?
b.How should the $250,000 sale price for the existing line be classified?
c.Depict all the known relevant cash flows on a time line.
VI. Book value Find the book value for each of the assets shown in the accompanying table, assuming that MACRS depreciation is being used. See Table for the applicable depreciation percentages.
|
Asset
|
Installed cost
|
Recovery period (years)
|
Elapsed time since purchase (years)
|
|
A
|
$ 950,000
|
5
|
3
|
|
B
|
40,000
|
3
|
1
|
|
C
|
96,000
|
5
|
4
|
|
D
|
350,000
|
5
|
1
|
|
E
|
1,500,000
|
7
|
5
|
VII. Book value and taxes on sale of assets Troy Industries purchased a new machine 3 years ago for $80,000. It is being depreciated under MACRS with a 5-year recovery period using the percentages given in Table. Assume a 40% tax rate.
a.What is thebook valueof the machine?
b.Calculate the firm's tax liability if it sold the machine for each of the following amounts: $100,000; $56,000; $23,200; and $15,000.
VIII. Tax calculations For each of the following cases, determine the total taxes resulting from the transaction. Assume a 40% tax rate. The asset was purchased 2 years ago for $200,000 and is being depreciated under MACRS using a 5-year recovery period. (See Table 4.2 on page 120 for the applicable depreciation percentages.)
a.The asset is sold for $220,000.
b.The asset is sold for $150,000.
c.The asset is sold for $96,000.
d.The asset is sold for $80,000.