PROBLEM 13-1

a. Purchase price of equipment
Additional investment in working capital
Initial investment outlay

9,000,000.00
3,000,000.00
12,000,000.00

b. No, last year’s $50,000 expenditure is considered a sunk cost and does not represent an incremental
cash flow. Hence, it should not be included in the analysis.

c. The potential sale of the building represents an opportunity cost of conducting the project in that
building. Therefore, the possible after-tax sale price must be charged against the project as a cost.

PROBLEM 13-2
a. Sales revenues
Operating costs
Depreciation
Operating income before taxes
Taxes (40%)
Operating income after taxes
Add back Depreciation
First year project cash flow

10,000,000.00
(7,000,000.00)
(2,000,000.00)
1,000,000.00
(400,000.00)
600,000.00
2,000,000.00
2,600,000.00

b. The cannibalization of existing sales needs to be considered in this analysis on an after-tax basis,
because the cannibalized sales represent sales revenue the firm would realize without the new
project but would lose if the new project is accepted. Thus, the after-tax effect would be to reduce
the project’s cash flow by $1,000,000(1 – T) = $1,000,000(0.6) = $600,000. Thus, the project’s
cash flow would now be $2,000,000 rather than $2,600,000.

c. Sales revenues
Operating costs
Depreciation
Operating income before taxes
Taxes (30%)
Operating income after taxes
Add back Depreciation
First year project cash flow

10,000,000.00
(7,000,000.00)
(2,000,000.00)
1,000,000.00
(300,000.00)
700,000.00
2,000,000.00
2,700,000.00

The project’s cash flow would increase by $100,000.
PROBLEM 13-3
Original cost of equipment
Depreciation (80%)
Book value
Selling price
Book value
Gain on sale

20,000,000.00
(16,000,000.00)
4,000,000.00
5,000,000.00
(4,000,000.00)
1,000,000.00

000.000 0.10 ) 0.000.000.00 200.000 / 4) Year 2 (800.10-10) 9.00 PROBLEM 13-4 Initial outlay Present value of cash inflows 1 . Straight-line depreciation Year 1 (800.(1.85 (12.174.301.921.131.407.000.11 2.10 SYSTEM B Initial outlay Present value of cash inflows 1.600.000.000.000. PROBLEM 13-5 SYSTEM A Initial outlay Present value of cash inflows 1 .000.10-6) 6.921.10 Net present value (40.11 / 1 .10 15.000.56 / 1 .131.000.00 .62 System A should be chosen because it has a higher EAA than System B.131.10 Chang should buy the new machine because the project has a positive net present value.000 14.10 ) 0.11 System B's EAA -3 2.10 Net present value of System A (20.301.56 6.000.(1.(1.56 System A's EAA -6 6.00) 4.00 (400.921.00) -3 1 .Selling price Tax on gain (1.00) 55.000 x 40%) After-tax net salvage value 5.00 200.000 0.00) 26.10 ) 0.(1.000 / 4) Year 3 (800. PROBLEM 13-6 a.10 Net present value of System B 6.000 / 4) 200.10 1.(1.

000.00 1.486852 4 (57.600.600.200.000 x 45%) Year 3 (800.735537 3 (32.000.600.200.00 (80.909091 2 64.00 120.000 .00) 2.73 111.00) (57.000.000 .600.000) (56.000 / 4) 200.169865 Net present value Difference 64.00 Year 1 2 3 4 MACRS .200.00) PV of cash flows 23.000.00) 3.000) (120.584.38 (79.26) (182.000 x 33%) Year 2 (800.579.000 x 7%) 264.SL (264.000) Year Cash flows PV factor 1 25.272.000.000.000) (360.00 64.200.000.00 MACRS accelerated depreciation Year 1 (800.41) Tax % 40% 40% 40% 40% Cash flows 25.00) .000.000 .00 56.b.000.000.00 360.000.000.000 x 15%) Year 4 (800.00 0.816.00 160.25) (127.00) (144. Year 4 (800.000 .000.00 (32.074.

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