Question 1:
Pierre Imports is evaluating the proposed acquisition of new equipment at a cost of $90,000. In addition the equipment would require modifications at a cost of $10,000 plus shipping costs of $2,000. The equipment falls into the MACRS 3-year class, and will be sold after 3 years for $35,000. The equipment would require increased inventory of 6,000. The equipment is expected to save the company $35,000 per year in before-tax operating costs. The company's marginal tax rate is 30 percent and its cost of capital is 11 percent.
a. What is the cash outflow at Time 0?
| Cost of milling machine |
$90,000 |
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| Modifications to machine |
$ 10,000 |
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| Shipping costs |
$ 2,000 |
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|
|
| MACRS 3 year class |
0.3333 |
0.4445 |
0.1481 |
0.0741 |
| Salvage after 3 years |
$ 35,000 |
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|
|
| Increased inventory |
$ 6,000 |
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|
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| Savings per year |
$ 35,000 |
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|
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| Tax rate |
30% |
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|
b. Calculate the net operating cash flows in years 1, 2, and 3?
c. Calculate the non-operating terminal year cash flow.
d. Calculate net present value. Should the machine be purchased?
Question 2. Andrews Corporation plans a $10 million expansion. The firm wants to maintain a 45 percent debt-to-total-assets ratio in its capital structure. It also wants to maintain its past dividend policy of distributing 30 percent of last year's net income. Last year, net income was $4 million.
a. Calculate the amount of external equity needed.
b. If the company changed to a residual dividend policy, how much external equity will it need?
c. Is the company likely to change to a residual policy? Why or why not?