Question

Will rate, thank you.

Part 1:

A project requires an initial investment of $100,000 and is expected to produce a cash inflow before tax of $27,500 per year for five years. Company A has substantial accumulated tax losses and is unlikely to pay taxes in the foreseeable future. Company B pays corporate taxes at a rate of 34% and can depreciate the investment for tax purposes using the five-year MACRS tax depreciation schedule. Suppose the opportunity cost of capital is 10%. Ignore inflation.

a. Calculate project NPV for each company. (Negative answers should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to the nearest whole dollar amount.)

	NPV
Company A	$
Company B	$

b-1. What is the IRR of the after-tax cash flows for each company? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)

	IRR
Company A	$ %
Company B	$ %

b-2. What does comparison of the IRRs suggest is the effective corporate tax rate? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)

Effective tax rate             %

Part 2:

Marsha Jones has bought a used Mercedes horse transporter for her Connecticut estate. It cost $40,000. The object is to save on horse transporter rentals.

Marsha had been renting a transporter every other week for $205 per week plus $1.25 per mile. Most of the trips are 90 miles in total. Marsha usually gives the driver a $40 tip. With the new transporter she will only have to pay for diesel fuel and maintenance, at about $.50 per mile. Insurance costs for Marsha’s transporter are $1,450 per year.

The transporter will probably be worth $20,000 (in real terms) after eight years, when Marsha’s horse Nike will be ready to retire. Assume a nominal discount rate of 10% and a forecasted inflation rate of 2%. Marsha’s transporter is a personal outlay, not a business or financial investment, so taxes can be ignored. Hint: All numbers given in the questions are in real terms. Assume CF at end of year, for simplicity.

Calculate the NPV of the investment. (Do not round intermediate calculations. Round your answer to the nearest whole dollar amount.)

NPV            $   

Part 3:

As a result of improvements in product engineering, United Automation is able to sell one of its two milling machines. Both machines perform the same function but differ in age. The newer machine could be sold today for $69,500. Its operating costs are $22,600 a year, but in five years the machine will require a $18,700 overhaul. Thereafter operating costs will be $31,300 until the machine is finally sold in year 10 for $6,950.

The older machine could be sold today for $26,300. If it is kept, it will need an immediate $26,500 overhaul. Thereafter operating costs will be $34,900 a year until the machine is finally sold in year 5 for $6,950.   

Both machines are fully depreciated for tax purposes. The company pays tax at 35%. Cash flows have been forecasted in real terms. The real cost of capital is 13%.

a. Calculate the equivalent annual costs for selling the new machine and for selling the old machine. (Do not round intermediate calculations. Enter your answers as a positive value rounded to 2 decimal places.)

	Equivalent Annual Cost
Sell new machine	$
Sell old machine	$

b. Which machine should United Automation sell?

     

	Sell new machine
	Sell old machine

Part 4:

Hayden Inc. has a number of copiers that were bought four years ago for $31,000. Currently maintenance costs $3,100 a year, but the maintenance agreement expires at the end of two years and thereafter the annual maintenance charge will rise to $9,100. The machines have a current resale value of $9,100, but at the end of year 2 their value will have fallen to $4,600. By the end of year 6 the machines will be valueless and would be scrapped.

Hayden is considering replacing the copiers with new machines that would do essentially the same job. These machines cost $26,000, and the company can take out an eight-year maintenance contract for $1,900 a year. The machines will have no value by the end of the eight years and will be scrapped.

Both machines are depreciated by using seven-year MACRS, and the tax rate is 40%. Assume for simplicity that the inflation rate is zero. The real cost of capital is 10%.

a. Calculate the equivalent annual cost, if the copiers are: (i) replaced now, (ii) replaced two years from now, or (iii) replaced six years from now. (Do not round intermediate calculations. Enter your answers as a positive value rounded to 2 decimal places.)

		Equivalent Annual Cost
(i) Replaced now	$
(ii) Replaced two years from now	$
(iii) Replaced six years from now	$

b. When should Hayden replace its copiers?

	Replace now
	Replace in two years
	Replace after six years

Answer 1

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