Capital Budgeting Problem Set - Building The Pride

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45. Although NPV and IRR give the same accept/reject decision they can often conflict when choosing between mutually exclusive projects. Why? 46. International Soup Company is considering replacing a canning machine. The old machine is being depreciated by the straight-line method over a 10-year recovery period from a depreciable cost basis of $120,000. The old machine has 5 years of remaining usable live, at which time its salvage value is expected to be zero, and it can be sold now for $40,000. This machine has a current book value of $60,000. The purchase price of the new machine is $250,000 and it will have shipping and installation costs of $12,500. It has a 5-year life and an expected salvage value of $25,000. Annual savings of electricity, labor and materials from use of the new machine are estimated at $40,000. The new machine will require an additional inventory of spare parts of $30,000. The company is in a 40 percent tax bracket, and its cost of capital is 16 percent. The machine will be depreciated straight line over its five-year life. What should the firm do? Show your work. ( NPV –91,448.31; IRR 0.18%; Payback 4.98) 47. You have become very successful and are considering the purchase of a plane for your firm. The Piper model has an initial cost of $375,000, annual operating costs of $24,000 and a salvage value of $150,000. Its estimated holding period is 7 years. The Cessna model has an initial cost of $325,000, but annual operating costs of $29,500 and an estimated salvage value of $100,000. Its estimated holding period is 8 years. Your cost of capital is fifteen percent. Ignoring depreciation and taxes, which model would be the best choice assuming they both would perform the required tasks? 48. We project unit sales for a new household-use laser-guided cockroach search and destroy system (a joint venture of Lockheed and Aerojet) as follows: Year 1 53,000 units Year 2 65,000 units Year 3 76,000 units Year 4 86,000 units Year 5 86,000 units The new system will be priced to sell at $95 each. The cockroach eradicator project will require $585,000 in new working capital. The variable cost per unit is $60, and total fixed costs are $25,000 per year. The equipment necessary to begin production will cost a total of $6,500,000. This equipment can be depreciated straight-line over its useful life of five years. In five years it will actually be worth about 30 percent of its cost. The relevant tax rate is 34%, and required return is 20%. Based on these preliminary estimates, what is the NPV of the project? (NPV -$224,835.20) 49. The Shadrach Corporation is thinking about replacing one of its large furnaces with a newer, more efficient model. The new model would cost $150,000, but would save $35,000 per year in fuel costs. The new model could be depreciated straight-line over its five year life to a salvage value of zero. The furnace could actually be sold for $45,000 at
that time. The old furnace cost $100,000 two years ago, could currently be sold for $60,000, and was being depreciated straight-line over its 7 year life. The old furnace was not expected to have any value at the end of its useful life in 5 years. Assuming a tax rate of 34% and a 12% required rate of return, should you replace the old furnace? (NPV 33,268.43) 50. Rick Bardles and Ed James are considering building a new bottling plant to meet expected future demand for their new line of tropical coolers. They are considering putting it on a plot of land they have owned for three years. They are in the process of analyzing the idea and comparing it to some others. Bardles says, “Ed, when we do this analysis, we should put in an amount for the cost of the land equal to what we paid for it. After all it did cost us a pretty penny.” James retorts, “No, I don’t care how much it costwe have already paid for it. It is what they call a sunk cost. The cost of the land shouldn’t be considered.” What would you say to Bardles and James? 51. Meals on Wings, Inc. supplies prepared meals for corporate aircraft (a opposed to airlines) and it needs to purchase new broilers. If the broilers are purchased, they will replace old broilers purchased 10 years ago for $105,000 and which are being depreciated on a straight-line basis to a zero salvage value (15-yeardepreciable life). The old broilers can be sold for $60,000 the new broilers will cost $200,000 installed and will be depreciated straight -line over their 5-year class life to a salvage value of zero, although they are expected to have a salvage value of $12,000 in five years. The firm expects to increase its revenues by $18,000 per year if the new broilers are purchased, but cash expenses will also increases by $2,500 per year. If the firm's cost of capital is 10 percent and its tax rate is 34 percent, what is the NPV of the broilers? (NPV -62,269.93) 52. You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck. The truck’s basic price is $50,000 and it will cost another $10,000 to modify it for special use by your firm. The truck falls into a fiveyear depreciation class and will be depreciated to zero over the five-year period. The truck is actually expected to be sold for $20,000 after three years when the project is ended. Use of the truck will require an increase in net working capital of $2,000 (spare parts). The truck will have no effect on revenue, but it is expected to save the firm $22,000 per year in before-tax operating costs, mainly labor. The firms marginal tax rate is 40 percent and the required rate of return on the project is 13 percent. What should you do?(NPV -$3143.27; IRR 10.39%) 53. You have been asked by the president of your firm to evaluate the proposed acquisition of spectrometer for the firm’s R&D department. The equipment’s base price is $140,000 and it would cost another $30,000 to modify it for special use by your firm. The spectrometer (plus the modification) would be depreciated straight-line over its five-year life to a salvage value of zero, but it is expected that the instrument would be sold after 3 years for $60,000. Use of the equipment would require an increase in net working capital (spare parts inventory) of $8,000. The spectrometer would have no effect on revenues, but it is expected to save the firm $50,000 per year in before-tax operating costs, mainly
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Capital Budgeting Problem Set - Building The Pride

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