Task1. Your company is considering replacing a fully depreciated machine which has a remaining useful life on 10 years with a newer, more refined machine. This new machine will cost $200,000 and will need $30,000 installation costs. It will be depreciated using MACRS 5 year (20%, 32%, 19%, 12%, 12%, and 5%). A $25,000 raise in net working capital will be needed to support the new machine. The management plans to evaluate the potential replacement over a 4-year period. They estimate which the old machine could be sold at the end of 4 years to net $15,000 before taxes; the new machine at the end of 4 years will be worth $75,000 before taxes. Compute the terminal cash flow at the end of year 4 that is relevant to the proposed purchase of new machine. The firm is subject to a 40% tax rate.
Task2. A company has been considering buying a new lathe to replace an old fully depreciated lathe that will last 5 more years. The new lathe is anticipated to have a 5-year life and depreciation charges of:
$2,000 in year 1
$3,200 in year 2
$1,900 in year 3
$1,200 in year 4
$1,200 in year 5
$500 in year 6
The firm estimates the revenues and expenses for the new and old lathes given below and the firm is in the 40% tax bracket.
Compute the Operating Cash Flows associated with each lathe.
OLD LATHE
Year Revenue Expenses Excluding Interest and Depreciation
1 $40,000 $30,000
2 $41,000 $30,000
3 $42,000 $30,000
4 $43,000 $30,000
5 $44,000 $30,000
OLD LATHE
Year Revenue Expenses Excluding Interest and Depreciation
1 $35,000 $25,000
2 $35,000 $25,000
3 $35,000 $25,000
4 $35,000 $25,000
5 $35,000 $25,000
Task3. Call and put options on Royal Dutch Shell have the strike price of 90, and expire in three months. The interest rate is 5 percent. The calls sell for 7.108, while the puts sell for 3.99. You can go short or long up to 15 units in puts, calls, or shares of stock of Royal Dutch Shell. Graph how much money you will make in three months using the arbitrage strategy as the stock price goes from 90 to 95. Be sure to describe your strategy.