Capital Budgeting

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1.)   Who Dat Restaurant is considering the purchase of a $10,600 soufflé maker. The soufflé maker has an economic life of five years and will be fully depreciated by the straight-line method. The machine will produce 2,300 soufflés per year, with each costing $2.70 to make and priced at $5.55. Assume that the discount rate is 16 percent and the tax rate is 40 percent.

 

What is the NPV of the project?

 

2.)   The Dante Manufacturing Company is considering a new investment. Financial projections for the investment are tabulated below. The corporate tax rate is 35 percent. Assume all sales revenue is received in cash, all operating costs and income taxes are paid in cash, and all cash flows occur at the end of the year. All net working capital is recovered at the end of the project.

 

   Year 0 Year 1 Year 2 Year 3 Year 4
  Investment $ 32,000                
  Sales revenue     $ 16,500 $ 17,000 $ 17,500 $ 14,500
  Operating costs       3,500   3,600   3,700   2,900
  Depreciation       8,000   8,000   8,000   8,000
  Net working capital  spending   380   430   480   380   ?

 

a. Compute the incremental net income of the investment for each year.
b. Compute the incremental cash flows of the investment for each year
c. Suppose the appropriate discount rate is 12 percent. What is the NPV of the project?

 

 

 

  • Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.58 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,040,000 in annual sales, with costs of $735,000. The project requires an initial investment in net working capital of $260,000, and the fixed asset will have a market value of $280,000 at the end of the project. If the tax rate is 34 percent,

What is the project’s Year 0 net cash flow?

Year 1?

Year 2?

Year 3?

If the required return is 15 percent, what is the project’s NPV?

 

4.)   Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.61 million. The fixed asset falls into the three-year MACRS class. The project is estimated to generate $2,050,000 in annual sales, with costs of $751,000. The project requires an initial investment in net working capital of $270,000, and the fixed asset will have a market value of $275,000 at the end of the project.

 

If the tax rate is 30 percent, what is the project’s year 1 net cash flow? Year 2? Year 3?

If the required return is 15 percent, what is the project’s NPV?

 

 

  • Your firm is contemplating the purchase of a new $595,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $63,000 at the end of that time. You will save $225,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $78,000 (this is a one-time reduction). If the tax rate is 35 percent, what is the IRR for this project?
  • An asset used in a four-year project falls in the five-year MACRS class for tax purposes. The asset has an acquisition cost of $6,140,000 and will be sold for $1,340,000 at the end of the project. If the tax rate is 30 percent, what is the aftertax salvage value of the asset?
  • You are evaluating two different silicon wafer milling machines. The Techron I costs $216,000, has a three-year life, and has pretax operating costs of $55,000 per year. The Techron II costs $380,000, has a five-year life, and has pretax operating costs of $28,000 per year. For both milling machines, use straight-line depreciation to zero over the project’s life and assume a salvage value of $32,000. If your tax rate is 35 percent and your discount rate is 10 percent, compute the EAC for both machines.
8.)   BOE Manufacturing is trying to decide between two different conveyor belt systems. System A costs $264,000, has a four-year life, and requires $81,000 in pretax annual operating costs. System B costs $372,000, has a six-year life, and requires $75,000 in pretax annual operating costs. Both systems are to be depreciated straight-line to zero over their lives and will have zero salvage value. Whichever project is chosen, it will not be replaced when it wears out. The tax rate is 34 percent and the discount rate is 8 percent.

 

Calculate the NPV for both conveyor belt systems.

 

  • AGT Golf Academy is evaluating different golf practice equipment. The “Dimple-Max” equipment costs $104,000, has a 5-year life, and costs $9,600 per year to operate. The relevant discount rate is 13 percent. Assume that the straight-line depreciation method is used and that the equipment is fully depreciated to zero. Furthermore, assume the equipment has a salvage value of $23,000 at the end of the project’s life. The relevant tax rate is 34 percent. All cash flows occur at the end of the year. What is the equivalent annual cost (EAC) of this equipment?

 

 

10.)                  Nata, Inc., is considering the purchase of a $368,000 computer with an economic life of five years. The computer will be fully depreciated over five years using the straight-line method. The market value of the computer will be $68,000 in five years. The computer will replace 5 office employees whose combined annual salaries are $113,000. The machine will also immediately lower the firm’s required net working capital by $88,000. This amount of net working capital will need to be replaced once the machine is sold. The corporate tax rate is 35 percent. The appropriate discount rate is 12 percent.

 

Calculate the NPV of this project.

 

11.)                  You have been hired as a consultant for Pristine Urban-Tech Zither, Inc. (PUTZ), manufacturers of fine zithers. The market for zithers is growing quickly. The company bought some land three years ago for $1.49 million in anticipation of using it as a toxic waste dump site but has recently hired another company to handle all toxic materials. Based on a recent appraisal, the company believes it could sell the land for $1,590,000 on an aftertax basis. In four years, the land could be sold for $1,690,000 after taxes. The company also hired a marketing firm to analyze the zither market, at a cost of $134,000. An excerpt of the marketing report is as follows:

 

The zither industry will have a rapid expansion in the next four years. With the brand name recognition that PUTZ brings to bear, we feel that the company will be able to sell 4,700, 5,600, 6,200, and 5,100 units each year for the next four years, respectively. Again, capitalizing on the name recognition of PUTZ, we feel that a premium price of $740 can be charged for each zither. Because zithers appear to be a fad, we feel at the end of the four-year period, sales should be discontinued.

 

PUTZ feels that fixed costs for the project will be $470,000 per year, and variable costs are 15 percent of sales. The equipment necessary for production will cost $4.4 million and will be depreciated according to a three-year MACRS schedule. At the end of the project, the equipment can be scrapped for $445,000. Net working capital of $134,000 will be required immediately and will be recaptured at the end of the project. PUTZ has a 40 percent tax rate, and the required return on the project is 13 percent. Assume the company has other profitable projects.

 

What is the NPV of the project?

 

 

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