Capital Budgeting Problem Set - Building The Pride

corporation has a 40% marginal tax rate and a cost of capital of 15%. What should
management do? (NPV –5,655.22; IRR 11.47%)
20. John Burke, Inc. is considering leasing a machine for eight years at an annual rental of
$34,000, which includes all maintenance. The alternative is to purchase the machine for
$190,000 and have maintenance expenses of $15,000 per year. However, if you purchase
the machine you get to depreciate it straight-line over the eight year period. Assume a
zero salvage value at the end of eight years and a 40% tax rate. The firm’s required rate
of return is 12%. Should the firm buy or lease? You will have to use your cash flow sheet
in order to determine the annual cost of purchasing the machine. (NPV –187,516.18;
EAC $37,747.54)
21. You are evaluating two different sound mixers. The JazzMaster costs $45,000 and has a
three-year life, and costs $5,000 per year to operate. The DiscoMaster costs $65,000, has
a five-year life and costs $4,000 per year to operate. The relevant discount rate is 12%.
Ignoring depreciation and taxes, compute the equivalent annual cost for both. Which do
you prefer? (EAC of JazzMaster 23,735.71; EAC of DiscoMaster 22,031.63)
22. What error(s) might be introduced by using nominal cash flows and discount rates to
calculate equivalent annual costs?
23. After the long drought of 1992, the manager of Long Branch Farm is considering the
installation of an irrigation system. The system has an invoice price of $100,000 and will
cost an additional $15,000 to install. It is estimated that it will increase revenues by
$20,000 annually, although operating expenses other than depreciation will also increase
by $5,000. The system will be depreciated straight-line over its depreciable life (5 years)
to a zero salvage value. The system can actually be sold for an estimated $25,000 at the
end of 5 years. If the tax rate on ordinary income is 40 percent and the firm’s required
rate of return is 16 percent, should the firm purchase the system? Why? Show your
work. (NPV –48,266.16; IRR –2.43%)
24. If Long Branch farms had spent $5,000 over the previous year doing studies of longrange
weather patterns in order to determine if they could use an irrigation system
effectively, how should that cost be taken into account in today’s analysis of this
particular irrigation system?
25. Top-Sider is considering the purchase of a new leather-cutting machine to replace an
existing machine that has a book value of $3,000 and can be sold today for $1,500. The
old machine is being depreciated on a straight-line basis and its estimated salvage value
in 3 years is zero. The new machine will reduce costs (before taxes) by $7,000 per year.
The new machine has a 3-year life, it costs $14,000, and it can be sold for an expected
$2,000 at the end of the third year. If the new machine is purchased it will require the
firm to maintain an additional $500 in spare parts inventory. The new machine would be
depreciated straight-line over its 3-year life. Assuming a 40 percent tax rate and a
required rate of return of 13 percent, what should the firm do? Show your work.