Capital Budgeting Problems Assignment

Capital Budgeting Problems Assignment

  1. 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.
  2. Matrix Printers, Inc. is considering entering the laser printing business. An entirely new plant will be needed which will cost $1,500,000. Land for the plant will cost an additional $250,000. Both of these costs will be incurred immediately. The plant will be depreciated straight line over its 15 year life. (Remember the rule about depreciating land.) In addition to these costs an investment of $100,000 will be needed for working capital. The plant will generate sales of $300,000 per year and have associated expenses of $175,000. The firms marginal tax rate is 34%. The plant will be sold in 15 years for $700,000.  What is the NPV of making this investment if the required rate of return is 16%. Should they make the investment?
  3. 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.

    Capital Budgeting Problems Assignment

  4. 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 five-year 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?
  5. Southwest Airlines is considering the purchase of a new baggage-handling machine that moves bags quicker and with less damage. The cost is $160,000. The machine will be depreciated using the straight line method over its seven year life. If the machine is purchased, SWA will save $31,000 per year in damaged bags costs during the first five years. Because of higher maintenance costs during the last two years the savings will only be $28,000. the firm is in a34% tax bracket. Given that the firm’s required rate of return is 13%, compute the NPV and IRR of the investment. Should they make the investment?
  6. Ball Corporation is currently evaluating two mutually exclusive projects which have the following net cash flows:                                   A                      B                                             A                         B                        0       -$5,000         -$10,000                           4                                3,500

    1        3,000        3,500                                    5                                3,500

    2        3,000        3,500                                    6                                 3,500

    3        3,000        3,500                              Capital Budgeting Problems Assignment

    • Both projects have a cost of capital of 10 percent.  Totally new equipment must be procured in 6 years, but Project A would be replicated if it were chosen.  Which project should Ball select, and why?
  7. Sony Corporation is considering the purchase of a new phone system for a sales office in Boise, Idaho.  The Lucent Technologies system costs $54,000, has annual operating expenses of $4,000 and an expected life of 9 years.  The Toshiba system has a cost of $48,000, annual operating expenses of $4,000 and an expected life of 7 years. Ignoring depreciation and taxes and assuming a cost of capital of 9 percent for such an investment, which system should Sony purchase?  You are free to use either replacement chain or EAA/EAC analysis.
  8. A small real estate office needs a new copier. They have their choice between leasing a new copier for $2,000 per year with all maintenance included or they can purchase their own copier for $4,200 and would incur $1,200 per year in operating costs. Paper and cartridge costs for the copier would be identical in either case. The lease would be for a total of 6 years and the copier, if bought, would have a useful life of 6 years and no expected salvage value at the end of that time. Determine if owning the machine would be cheaper on a per-year basis than leasing the machine. Then firm’s tax rate is 34% and the proper required rate of return for the project would be 7%. Capital Budgeting Problems Assignment
  9. 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?

Capital Budgeting Problems Assignment

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