Chapter 08 Solutions

Solutions to Chapter 8 Problems
A Note To Instructors: Because of volatile energy prices in today's world, the instructor is encouraged to vary energy
prices in affected problems (e.g. the price of a gallon of gasoline) plus and minus 50 percent and ask students to
determine whether this range of prices changes the recommendation in the problem. This should make for stimulating in-
class discussion of the results.
8-1 At 3% annual inflation, it will take 72 / 3 = 24 years to half the value of today's money. At 4% annual
inflation, it will take 72 / 4 = 18 years to dwindle to half of today's value.
550
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8-2 A = $1,000; N = 10
(a) f = 6% per year; ir = 4% per year

In Part (a), the $1,000 is an A$ uniform cash flow (annuity)
im = 0.04 + 0.06 + (0.04)(0.06) = 0.1024, or 10.24% per year
PW(im) = $1,000 (P/A,10.24%,10) = $1,000(6.0817) = $6,082
(b) In Part (b), the $1,000 is a R$ uniform cash flow (annuity) because the A$ cash flow is $1,000
(1.06)k where 1 ≤ k ≤ 10; i.e.,
k-b k-0
⎛ 1 ⎞ k⎛1 ⎞
(R$)k = (A$)k ⎜ ⎟ = $1,000 (1.06) ⎜ ⎟ = $1,000; 1 ≤ k ≤ 10
⎝1+ f ⎠ ⎝ 1 + 0.06 ⎠
PW(ir) = $1,000 (P/A,4%,10) = $8,111
551
8-3 The average rate of inflation is 10% per year, and the market place interest rate is
5% + 10% + (5%)(10%) = 15.5% per year.
PW2 = ($1,000)
[1 − ( P / F ,15.5%,23)( F / P,10%,23)] = $12,262.36
0.155 − 0.10
PW0 = $12,262.36 (P/F, 15.5%, 2) = $9,192.
552
8-4 In ten years a service/commodity that increases at the 4% general inflation rate will cost (F/P, 4%, 10) =
1.4802 times its current cost. But health care costs will increase to (F/P, 12%, 10) = 3.1058 times their
current value. The ratio of 3.1058 to 1.4802 is 2.10, which means that health care will cost 210% more
than an inflation-indexed service/commodity in ten years.
553
8-5 Situation a: FW5 (A$) = $2,500 (F/P, 8%, 5) = $2,500 (1.4693) = $3,673
Situation b: FW5 (A$) = $4,000 (given)
Choose situation b. (Note: The general inflation rate, 5%, is a distractor not needed in the solution.)
554
8-6
EOY Project A Project B
A($) (P/F, fr, k–b) R($) (Real $) at b = 0
1 100,000 0.9615 $96,150 $80,000
2 112,000 0.9246 $103,555.2 $100,000
3 136,000 0.8890 $120,904 $120,000
4 150,000 0.2548 $128,220 $140,000
–$448,829.2 –$440,000
Project B has least negative equivalent worth.
555
8-7 80 = 8(F/P, i %, 60) = 8(1+i) 60
(a) (1+i)60 = 10 ⇒ i = 3.91% per year
(b) (1+i)60 = 50 ⇒ i = 6.73% per year
Effective interest rate = 6.73 – 3.91 = 2.82%
556
8-8 $40 = $0.01 (F/P, i%, 4) = $0.01 (1 + i)4
(1 + i)4 = 4,000
1 + i = 7.95
i = 6.95 or 695%
557
8-9
EOY Profit A($) CPI Annual R ($), Ans.
change
rate
1 5,000 2.6 2.6 5,000(P/F, 2.6%, 1)= $48,732
2 42,000 1.8 -30.76 42,000(P/F, -30.76%, 2)= $85,714.28
3 38,100 1.5 -16.6 381,000(P/F, -16.6%, 3)= $64,019.70
4 40,000 3.2 -13.3 40,000(P/F, 13.3%, 1)= $24,273.94
558
8-10 A($) = R($) (1+ f ) k–b =15,000(1 + 0.03)5 = $17,389.11
40,000 x [(1.08)10 + (1.06) (1.08)9 + (1.06)2 (1.08)8 + …. + (1.06)9 (1.08) + (1.06)10] = 17,389.11
or, x = 2.00%
559
(0)
8-11 R$ 10 = $400M(1.75) = $700M
A$10 = $920M = $700M(1+f)10
1.314 = (1+f)10
10
f= 1.314 − 1 = 0.0277 or 2.77%
560
8-12 Budget = $100,000, million; In 2020, Budget = $150,000 million; A$ = $500,000 million
1
R($) = (A$) k − b ⇒ k − b = 10
(1 + f )
∴ f = 12.79 % Annual inflation rate
561
8-13 F = $100,000(F/P, 10%, 10) = $259,370 Taxable Earnings = $159,370
After-tax F = $159,370(1 – 0.33) + $100,000 = $206,778
F (in today’s purchasing power) = $206,778 (P/F, 3%, 10) = $153,864
Your younger brother is ahead by about $43,400 with his concern over performance (total return) rather
than risk avoidance (safety).
562
8-14 Unit cost (8 years ago) = $89 / ft2 SB = 80,000 ft2
X = 0.92 SA = 125,000 ft2
eC = 5.4% per year im = MARRc = 12% per year
eAE = 5.66% per year f = 7.69% per year
(a) Using the power sizing technique (exponential cost estimating model) from Section 3.4.1, with an
adjustment for the price increase in construction costs, we have:
X
⎛S ⎞
CA = CB ⎜ A ⎟ (1 + eC)8
⎝ SB ⎠
0.92
⎛ 125,000⎞
2
= ($89/ft )(80,000 ft ) ⎜ 2
⎟ (1.054)8
⎝ 80,000 ⎠
= $16,350,060
Total Capital Investment = $16,350,060 (1 + 0.05 + 0.042 + 0.08 + 0.31)

= $24,230,790
(b) Note: The building is not being sold at the end of the 10 years. Therefore, working capital is not
considered to be recovered at that time.
PW(12%) = −$24,230,790 – ($5)(125,000 ft2)

[1 − ( P / F ,12%,10)( F / P,5.66%,10)]
0.12 − 0.0566
625,000(0.4416)
= −$24,230,790 –
0.0634
= −$28,584,102
0.12 - 0.0769
(c) ir = = 0.04 or 4% per year
1.0769
Assuming the base year to be the present (b = 0), we have:
AW(4%) = −$28,584,102 (A/P,4%,10) = −$3,524,420
563
8-15 (a) $10,000(6.07) = $60,700
(b) R$20 = $60,700(P/F, 6%, 20) = $18,926.50
(c) $10,000(1 + ir)20 = $18,926.50

ir = 3.24%
(d) P2 = $10,000(1 – 0.18)(1 – 0.33) = $5,658

$5,658(1 + im)18 = $60,700
im = 14.1%
564
8-16 We can equate future worth's in 20 years. The FW of her savings plan will be P(1.05)20 and the FW of
the $400,000 if it were to inflate at 7% per year is $400,000(1.07)20. P is what we are trying to
determine. So we can equate these two amounts as follows:
P(1.05)20 = $400,000(1.07)20 or P = $400,000(1.07 / 1.05)20.
This equals $400,000(1.01905)20 = $583,377. She must now put away more than $400,000 because
inflation each year is greater than the interest rate on her savings account. This demonstrates the
injurious effect of high inflation in an economy.
565
8-17 f = 4%, MARR = 8.5%
im − f 0.085 − 0.04
ir = = = 4.32%
1+ f 1 + 0.04
566
8-18 (a) Lump sum interest in 2010 = ($2.4 billion/5)(F/A, 10%, 5) – 2.4 billion
= $530,448,000
0.91
⎛ 200,000 ⎞
(b) C2005 = ($2.4 billion) ⎜ ⎟ = $3.12 billion
⎝ 150,000 ⎠
(c) C2015 = ($3.12 billion)(F/P, 9.2%, 10) = $7.52 billion
567
8-19 (a) R$28 = $690(P/F, 3.2%, 28) = $285.64
(b) $850 = $690(1.032)N; N = 6.62 years
(c) $285.56 = $850(1 + ir)28; ir = −3.82%

This was not a good investment to have made in January of 1980.
568
8-20 (a) Cost in year 2020 = $15,000 (F/P,6%,15) = $35,949
Cost in year 2021 = $38,106
Cost in year 2022 = $40,392
Cost in year 2023 = $42,816
Total (un−discounted dollars) = $157,263
(b) Because im = f , P2020 = 4($35,949) = $143,796

so A = $143,796 (A/P,0.5%,156 months)
= $143,796 (0.00925)
= $1,330 per month
569
1 6, 000
8-21 (a) R($) = A($) k −b
= = $3, 322.054
(1 + f ) (1 + 0.03) 20
(b) A($) = R ($)(1 + f ) k − b = 6, 000(1 + 0.04) 20 = $13,146.73
570
8-22 (a) From Equation (8-1), we see that real dollars as of year k = 0 (today) is $1,107,706(P/F, 3%, 60) =
$187,978 which is still a tidy sum of purchasing power.
(b) When f = 2% per year, we have R$0 = $1,107,706(P/F, 2%, 60) = $337,629. The impact of
inflation is clear when you compare the results of Parts (a) and (b).
571
⎛ 2,400 ft 2 ⎞
8-23 (a) Cost in 10 years = ($3.75/lb)(400 lb)⎜⎜ 2
⎟⎟(1.085)10 = $3,700
⎝ 2,200 ft ⎠
(b) Left to student.
572
8-24 You’ve got to be kidding! You have foregone 10% per year earnings on your money to save 5% per
year on postage stamps? Give me a break. The U.S. Postal Service might just get away with this ruse.
Only time will tell.
573
8-25 Based on Equation (4-28), we have
[1 − (0.0668)(3.2620)]
PW = $2.5 billion = $48.88 billion and AW = $3.67 billion.
0.07 − 0.03
With inflation considered in this problem, the taxpayers can afford to increase the subsidy for the F-T
technology.
574
8-26 $20,000 = $10,000(F/P,im,11) or im = 0.065 (6.5%) per year.
ir= (im−f)/(1+f) = (0.065−0.03)/(1.03) = 0.03398 or 3.4% per year.
This is a failrly good return in real terms. Historically, real returns have been in the 2−3% per year ball
park.
575
8-27 ir = 10.05% per year; f = 4.5% per year; f = ej = 6.3% per year
im = 0.1005 + 0.045 + (0.1005)(0.045) = 0.15 or 15% per year
iCR = (0.15 − 0.063) / 0.063 = 0.0818 or 8.18% per year
MV7 = (0.15)($838,000) = $125,700
PW(15%) = −$838,000 − $92,600(P/A, 8.18%, 7) + $125,700(P/F, 15%, 7) = −$1,269,908
Annual Revenue = $1,269,908 (A/P, 15%, 7) = $305,286
576
8-28 Machine A
EOY BTCF Depreciation Taxable income Taxes (40%) ATCF
0 –10,000 – – – –$10,000
1 –500 +2,000 –2,500 1,000 500
2 –550 3,200 –2,750 1,100 550
3 –610 1,920 –2,530 1,012 402
4 –671 1,152 –1,823 729.2 58.2
5 –738.1 1,152 –1,890.1 756.04 17.94
6 –811.91 576 –1,387.91 555.164 –256.74
–$8,728.6
Machine B
EOY BTCF Depreciation Taxable Tax (40%) ATCF

income
0 –12,000 – – – –12,000
1 –200 +2,400 –2,600 1,040 840
2 –220 +3,840 –4,060 1,629 1,409
3 –242 2,304 –2,546 1,018.4 776.4
4 –266.2 1,382.4 –1,648.6 659.44 393.29
5 –292.82 1,382.4 –1,675.22 670.08 377.26
6 322.10 691.4 –322.791 129.11 –192.99
∑ = −$8397.04
Machine B is better.
577
$20(F/P, 22.5%, N)
8-29 > 5. One approach would be to find the minimum value of N by trial and error.
$10(F/P, 13.1%, N)
At N = 12 years, the cost of an RA dose is $228.38 and the cost of a diabetes inhaler use is $43.81. The
ratio of RA to diabetes is 5.21, so N = 12 years wil “git ‘er done.”
578
8-30 Option 1: Software with 3 year upgrade agreement.
(A) (B) Taxable Cash Flow

Year BTCF Depreci− Income: for ATCF
(A$) ation C=A+B Income (A$)
Taxes A+D
D = −t(C)
0 −$X −−− −−− −−− −$X
1 0 $X/3 −$X/3 $0.1133X $0.1133X
2 0 $X/3 −$X/3 $0.1133X $0.1133X
3 0 $X/3 −$X/3 $0.1133X $0.1133X
PW1(20%) = −$X + $0.1133X(P/A,20%,3)
(A) (B) Taxable Cash Flow

Year BTCF Depreci− Income: for ATCF
(A$) ation C=A+B Income (A$)
Taxes A+D
D = −t(C)
1 −$20,000 −−− − $20,000 $6,800 −$13,200
2 − 22,000 −−− − 22,000 7,480 − 14,520
3 − 24,200 −−− − 24,200 8,228 − 15,972
PW2(20%) = −$13,200(P/F,20%,1) − $14,520(P/F,20%,2) − $15,972(P/F,20%,3)

= −$30,326
Set PW1 = PW2 and solve for X.
−$X + $0.1133X(P/A,20%,3) = −$30,326
−$0.761X = −$30,326
X = $39,836
Therefore, $39,836 could be spent for software with a 3 year upgrade agreement (i.e., Option 1).
579
8-31 $1 / 0.55 pound = $1.82 per pound
$1.82 per pound / 1.4 euro per pound = $1.30 per euro, or 1 U.S. dollor will buy 0.77 euro.
580
8-32 In 2005 there was parity between the U.S. dollar and the Real. But in 2010 one Real is worth $0.50
U.S., so the investment is now worth $50 million and the bank has suffered a major loss. Conventional
wisdom would be to cut the losses instead of chasing bad money with good money (i.e. sell out).
581
8-33 (a) In two years: $1 (1.026)2 = 6.4X
or, $1 = 6.4X / (1.026)2 = 6.08 units of X.
(b) In three years: $1 = (6.4X) (1.026)3
= 6.91 units of X.
582
8-34 (a) The value of 0.5 pound Sterling is 90 cents, so 5 cents can be saved on each item purchased in U.S.
dollars.
(b) 100,000 items × $0.05 = $5,000 can be saved by purchasing in the U.S.
583
8-35 (a) ius = 0.2; f e = 0.08
if m − f e
ius = .
1 + fe
if m = ius + f e + f e (ius ) = 0.2 + 0.08 + 0.08 × 0.2

= 0.296
if m = 29.6%
(b) f e = 0.05
if m = 0.2 − 0.05 − 0.05 × 0.2 = 14%
584
8-36 Left to student.
585
8-37 (a)
Exchange
NCF Rate NCF
EOY (T−marks) (T−marks/$) ($) PW(18%)
0 −$3,600,000 20.000 −$180,000 − $180,000
1 450,000 22.400 20,089 17,025
2 1,500,000 25.088 59,790 42,941
3 1,500,000 28.099 53,383 32,489
4 1,500,000 31.470 47,664 24,585
5 1,500,000 35.247 42,557 18,602
6 1,500,000 39.476 37,998 14,074
7 1,500,000 44.214 33,926 10,649
PW (18%) = − $19,635
Project is not economically acceptable.

(b) IRRfm in terms of T−marks:
PW(i'%) = −3,600,000 + 450,000 (P/F, i'%, 1)
+ 1,500,000 (P/A, i'%, 6) (P/F, i'%, 1)
By linear interpolation, i'% = IRRfm = 0.2798, or 28.0% per year.

(c) From Equation 8-7, we have:
IRR fm - f e 0.28 - 0.12
(IRR)US = = = 0.1429, or 14.29% < 18%
1+ fe 1.12
Note: This confirms our recommendation in part (a).
586
8-38 100 euros × $1.24 = $124. The cost in U.S. dollars is $124 + $40 = $164. Sanjay may think he is
paying too much for the jewelry, but he goes ahead with the purchase anyway. He could have converted
his 100 euros into U.S. dollars, but there is a 7.5 euro commission on the transaction. Or he could have
kept his 100 euros for the next trip he makes to Europe and simply charge the purchase to his credit
card.
587
8-39 ifm = 20% per year; fe = −2.2% per year
Current exchange rate = $1 per 92 Z−Krons
0.20 - (-0.022)
i US = = 22.7%
1 - 0.022
PW(22.7%) = −$168,000,000 − $32,000,000(P/F,22.7%,1)
+ $69,000,000(P/A,22.7%,9)(P/F,22.7%,1)
= −$168,000,000 − $32,000,000(0.8150) + $69,000,000(3.7065)(0.8150)
= $14,355,028 > 0
Yes, this project will meet the company's economic decision criteria.
588
8-40 (a)
(A) (B) (C) (D) (E) (F) (G)

Year BTCF Adjustment BTCF Lease Taxable Cash ATCF
(R$) (1.10)Year (A$) Payment Income: Flow for (A$)
(A$) (C) – (D) Income C−D+F
Taxes
−t(E)
1 − $4,000 1.100 −$4,400 $80,000 $84,000 $33,760 −$50,640
2 − 4,000 1.210 − 4,840 60,000 − 64,840 25,936 − 38,904
3 − 4,000 1.331 − 5,324 50,000 − 55,324 22,130 − 33,194
4 − 4,000 1.464 − 5,856 50,000 − 55,856 22,342 − 33,514
5 − 4,000 1.611 − 6,442 50,000 − 56,442 22,577 − 33,865
6 − 4,000 1.772 − 7,086 50,000 − 57,086 22,834 −34,252
(b) im = (1.05)(1.09524) – 1 = 0.15 = 15% per year
PW = −$50,640(P/F,15%,1) − $38,904(P/F,15%,2) − $33,194(P/F,15%,3)

− $33,514(P/F,15%,4) − $33,865(P/F,15%,5) − $34,252(P/F,15%,6)
= −$146,084
EUAC = $146,084(A/P,15%,6) = $38,595
589
8-41 70 × 106 k cal / hr
P = 100, 000(1 + 0.05)5 = $127, 628.16
Cost of new finance

0.75
⎛ 100 × 106 ⎞
= 127, 628.16 ⎜ 6 ⎟
⎝ 70 × 10 ⎠
= $166, 771.939
590
8-42
The cost of expansion device at EOY 10th
A($) = $800(1 + 0.05)10 = $13, 013.11
Annual maintenance expenses: A, (A$) = $200(1.05) = $210
Annual electricity expenses: A = ( A$) = $1, 200(1.10) = $1, 320
PW (15%) = −$5, 000 − $13, 013( P /F ,15%,10)

−$210[1 − ( P /F ,15%, 20)( F /P, 5%, 20)]
0.15 − 0.05
−$1, 320[1 − ( P /F ,15%, 20)( F /P,10%, 20)]

0.15 − 0.10
= −$5, 000 − 1, 759.55 − 15, 548.27 = −$22, 307.82
AW (15%), A$ = −22, 307.82 ( A/P,15%, 20)

(a)
= −$3, 564.79
0.15 − 0.05
ir = = 9.5%
1.05
AW (15%), R($) = −22, 307.82( A/P, 9.5%, 20)

(b)
= −$2, 531.41
591
8-43
EOY A($) Cash Depreciation BTCF Annual Taxable Income Tax = – ATCF
flow EXP income t/(c) 1
R ($) A($)
(1 + f ) k −b
0 –25,000 – – – – – –25,000
1 10,400 5,000 8,400 –2,000 3,400 –1,360 6,769.2
2 11,664 8,000 9504 –2,160 1,504 –601.6 7,632.3
3 12,597.12 4,800 10,204.3 –2,332.8 5,464.32 –2,185.5 6,413.22

2
4 13,604.89 2,880 11,085.4 –2,519.42 8,205.47 –3,282 6,670.43

7
5 14,693.28 2,880 11,972.3 –2,720.97 9,092.31 –3,637 8,207.98
6 15,868.74 1,440 12,930.0 –29,38.65 11,490.09 –4,596 6,586.55

9
8-44 C = 500,000, 3Year GDS

592
AR = $800,000 → 2.5%
AE = $575,000 → 5.6%
MV = $80,000
f = 4.9%; MARR(After tax) =10%, t = 40%
EOY C AR AE BTCF Depreciati Taxable Income ATCF After Tax

on income Tax = −t A($) R($) =
(c) A($)/(1+ f
)k–b
0 –500,000 – – –500,000 – – – 500,000 500,000
1 – 800,000 –575,000 225,000 +100,000 125,000 –50,000 175,000 166,825.5
2 – 820,000 –607,200 212,800 +160,000 52,800 –21,120 191,680 174,191.04
3 – 840,000 –641,203.2 199,296.8 +96,000 103,296.8 –41,318.7 157,978.1 136,858.07
4 – 861,512.5 –677,110.58 184,401.9 +57,600 126,801.9 – 133,681.2 110,399.82

50,720.76
5 – 883,050.3 –715,028.77 168,021.5 +57,600 110,421.5 –44,168.6 123,8529 97,505.416
6 – 905,126.5 –755,070.38 150,056.12 +28,800 121,256.12 –48,502.4 101,553.72 76,215.416
im − f 10 − 0.049
ir = = = 0.04861 = 4.8%
1+ f 1 + 0.049
PW = −500, 000 + 166, 825.5 ( P /F , 4.8%,1) + 174,191.04 ( P /F , 4.8%, 2)
+ 136, 858.07 ( P /F , 4.8%, 3) + 110, 399.82 ( P /F , 4.8%, 4) +

97, 505.416 ( P /F , 4.8%, 5) + 76, 215.416 ( P /F , 4.8%, 6)
−$158, 864.4
593
8-45 Purchase (A$ Analysis):
Oper., Ins. &
Investment / Other Expenses Maintenance
EOY Market (O,I,OE) Expense BTCF
Value
0 − $600,000 − $600,000
1 − $27,560b − $34,880c − 62,440
2 − 29,214 − 38,019 − 67,233
3 − 30,966 − 41,441 − 72,407
4 − 32,824 − 45,171 − 77,995
5 − 34,794 − 49,236 − 84,030
6 − 36,881 − 53,667 − 90,549
6 101,355a 101,355
ATCF
EOY BTCF Deprd TI T(34%) (A$)
0 − $600,000 − $600,000
1 − 62,440 $120,000 − $182,440 $62,030 − 410
2 − 67,233 192,000 − 259,233 88,139 20,906
3 − 72,407 115,200 − 187,607 63,786 − 8,621
4 − 77,995 69,120 − 147,115 50,019 − 27,976
5 − 84,030 69,120 − 153,150 52,071 − 31,959
6 − 90,549 34,560 − 125,108 42,537 − 48,012
6 101,355 101,355 − 34,461 66,894
Notes:
a
(MV)6 = $90,000 (1.02)6 = $101,355
b
(O,I,OE)k = $26,000 (1.06)k
c
(Maint)k = $32,000 (1.09)k
d
Cost Basis = $600,000
im = 0.13208 + 0.06 + (0.13208)(0.06) = 0.20, or 20% per year

6
FW6 (A$) = ∑ ATCF (F/P, 20%, 6 − k) = − $1,823,920
k=0
k
594
8-45 continued
Lease (A$ Analysis):

Leasing Oper., Ins. & Maint.
EOY Costs Other Expenses Expense BTCF
1 − $300,000 − $27,560 − $34,880 − $362,440
2 − 200,000 − 29,214 − 38,019 − 267,233
3 − 200,000 − 30,966 − 41,441 − 272,407
4 − 200,000 − 32,824 − 45,171 − 277,995
5 − 200,000 − 34,794 − 49,236 − 284,030
6 − 200,000 − 36,881 − 53,667 − 290,549
ATCF
EOY BTCF Depr TI T(34%) (A$)
1 − $362,440 0 − $362,440 $123,230 − $239,210
2 − 267,233 0 − 267,233 90,859 − 176,374
3 − 272,407 0 − 272,407 92,618 − 179,789
4 − 277,995 0 − 277,995 94,518 − 183,477
5 − 284,030 0 − 284,030 96,570 − 187,460
6 − 290,549 0 − 290,549 98,787 − 191,762
6
FW6 (A$) = ∑ ATCF (F/P, 20%, 6 − k) = − $1,952,551
k=0
k
Therefore choose Purchase Alternative due to smaller FW of costs.
595
8-46 Assuming that EOY 1 cost for purchased components is $85,000,000
EOY Cash Flow (w) Cash Flow (w/o)

0 −20,000,000 0
1 −85,000,000 −85,000,000
2 −80,750,000 −85,000,000
3 −76,712,500 −85,000,000
4 −72,876,875 −85,000,000
5 −69,233,031 −85,000,000
PW −300,467,957 −306,405,977
i(r) = 0.178947368
(P/A,i(r),5) = 3.134641881
PW(w) = −20,000,000 – (85,000,000/(1−.05))[P/A,((0.12+0.05)/(1−0.05)),5]
= −300,467,957.81
PW(w/o) = −85,000,000(P/A,12%,5) = −306,405,977.20

PW(Difference) = $5,938,019.39
AW(Difference) = $1,647,264.37
Assuming that EOY 1 cost for purchased components is $85,000,000 (1−0.05)
EOY Cash Flow (w) Cash Flow (w/o)

0 −20,000,000.00 0.00
1 −80,750,000.00 −85,000,000.00
2 −76,712,500.00 −85,000,000.00
3 −72,876,875.00 −85,000,000.00
4 −69,233,031.25 −85,000,000.00
5 −65,771,379.69 −85,000,000.00
PW −286,444,559.92 −306,405,977.20
i(r) = 0.178947368
(P/A,i(r),5) = 3.134641881
PW(w) = −20,000,000 – 85,000,000[P/A,((0.12+0.05)/(1−0.05)),5]
= −286,444,559.92
PW(w/o) = −85,000,000(P/A,12%,5) = −306,405,977.20

PW(Difference) = $19,961,417.28
AW(Difference) = $5,537,491.42
596
8-47 Left to student.
597
8-48 This is intended to be a tailor-made exercise (at the discretion of the instructor).
Assumptions:
• Salary and fringe benefits for the new analyst will be $28,000 (1.3) = $36,400 in year 1
purchasing power. This increases 6% per year thereafter.
• Staff retirements occur at the end of the year. Therefore, there are no realized savings in year 1.
Savings of $16,200 in year 2, $32,400 in year 3, and $48,600 each year thereafter are expressed in
real purchasing power keyed to year 0.
• First−year savings on purchases are 3% of $1,000,000 (1.10) = $33,000 and this increases by 10%
per year thereafter.
• Contingency costs will not be considered as cash flows until they are spent (we assume they won’t
be spent).
• The effective income tax rate is = 38%.
• There is no market value at the end of the 6−year project life.
Capital Service New Manpower Savings on Total

EOY Investment Contract Analyst Savings Purchases BTCF
0 − $80,000 −$80,000
1 − $6,000 −$36,400 $ 0 $33,000 − 9,400
2 − 6,000 − 38,584 18,202 36,300 9,918
3 − 6,000 − 40,899 38,588 39,930 31,619
4 − 6,000 − 43,353 61,356 43,923 55,926
5 − 6,000 − 45,954 65,037 48,315 61,398
6 − 6,000 − 48,711 68,940 53,147 67,376
ATCF
EOY BTCF Depr. TI T(38%) (A$)
0 −$80,000 −−− −−− −−− −$80,000
1 −9,400 $16,000 −$25,400 $9,652 252
2 9,918 25,600 −15,682 5,959 15,877
3 31,619 15,360 16,259 −6,178 25,441
4 55,926 9,216 46,710 −17,750 38,176
5 61,398 9,216 52,182 −19,829 41,569
6 67,376 4,608 62,768 −23,852 43,524
6
PW (15%) = ∑ ATCF (P/F, 15%, k) = $10,263
k=0
k
In view of MARR of 15%, this investment should be undertaken. The instructor may wish to ask the class to explore various “what
if” questions involving changes in the assumptions listed above. For example, how much change would occur in the PW value if we
assume staff retirements occur at the beginning of the year?)
598
Solutions to Spreadsheet Exercises
8-49 See P8-49.xls.
Typical solution for (*) is (P/F, 4%, 10) = 0.6756, so 32.44% of purchasing power has been lost due to
inflation. This rounds to −32%.
Erosion of Money's Purchasing Power
(years)
10 15 25
Inflation 2% ‐18% ‐26% ‐39%
Rate 3% ‐26% ‐36% ‐52%
4% ‐32%* ‐44% ‐62%
8-50 See P8-50.xls.

599

% Salary
to Save
Starting Salary = $ 60,000 Annually 8.64% 864
Annual Salary Increase = 8.00%
Savings Interest Rate = 7.50%
Average Inflation Rate = 3.75%
Desired amount in 2027 (R$) = $ 500,000
Desired Amount in 2027 (A$) = $1,508,736
Savings Bank Balance
Year Salary (A$) (A$) (A$)
1997 $ 60,000 $ 5,184 $ 5,184
1998 $ 64,800 $ 5,599 $ 11,172
1999 $ 69,984 $ 6,047 $ 18,056
2000 $ 75,583 $ 6,530 $ 25,941
2001 $ 81,629 $ 7,053 $ 34,939
2002 $ 88,160 $ 7,617 $ 45,176
2003 $ 95,212 $ 8,226 $ 56,791
2004 $ 102,829 $ 8,884 $ 69,935
2005 $ 111,056 $ 9,595 $ 84,775
2006 $ 119,940 $ 10,363 $ 101,496
2007 $ 129,535 $ 11,192 $ 120,300
2008 $ 139,898 $ 12,087 $ 141,410
2009 $ 151,090 $ 13,054 $ 165,070
2010 $ 163,177 $ 14,099 $ 191,548
2011 $ 176,232 $ 15,226 $ 221,141
2012 $ 190,330 $ 16,445 $ 254,171
2013 $ 205,557 $ 17,760 $ 290,994
2014 $ 222,001 $ 19,181 $ 331,999
2015 $ 239,761 $ 20,715 $ 377,615
2016 $ 258,942 $ 22,373 $ 428,308
2017 $ 279,657 $ 24,162 $ 484,594
2018 $ 302,030 $ 26,095 $ 547,034
2019 $ 326,192 $ 28,183 $ 616,244
2020 $ 352,288 $ 30,438 $ 692,900
2021 $ 380,471 $ 32,873 $ 777,741
2022 $ 410,909 $ 35,502 $ 871,574
2023 $ 443,781 $ 38,343 $ 975,284
2024 $ 479,284 $ 41,410 $ 1,089,841
2025 $ 517,626 $ 44,723 $ 1,216,302
2026 $ 559,036 $ 48,301 $ 1,355,825
600
2027 $ 603,759 $ 52,165 $ 1,509,677
Difference between Desired and Actual = $ 941
601
8-51 f = 4.5% per year; im (after−tax) = 12% per year; t = 40%; b = 0
increase rate = 6 % per year (applies to annual expenses, replacement costs, and market value)
Analysis period = 20 years; Useful life = 10 years
MACRS (GDS) 5−year property class
Capital investment (and cost basis, B) = −$260,000
Market value (at end of year 10) in year 0 dollars = $50,000
Annual expenses (in year 0 dollars) = −$6,000
Annual property tax = 4% of capital investment (does not inflate)
Assume like replacement at end of year 10.
Annual Property ATCF ATCF*

EOY Expenses Taxes BTCF Depr. TI T(40%) (A$) (R$)
0 -$260,000 -$260,000 -$260,000
1 -$6,360 -$10,400 -16,760 52,000 -68,760 27,504 10,744 10,281
2 -6,742 -10,400 -17,142 83,200 -100,342 40,137 22,995 21,057
3 -7,146 -10,400 -17,546 49,920 -67,466 26,986 9,440 8,272
4 -7,575 -10,400 -17,975 29,952 -47,927 19,171 1,196 1,003
5 -8,029 -10,400 -18,429 29,952 -48,381 19,352 923 741
6 -8,511 -10,400 -18,911 14,976 -33,887 13,555 -5,356 -4,113
7 -9,022 -10,400 -19,422 0 -19,422 7,769 -11,653 -8,563
8 -9,563 -10,400 -19,963 0 -19,963 7,985 -11,978 -8,423
9 -10,137 -10,400 -20,537 0 -20,537 8,215 -12,322 -8,292
10 -10,745 -10,400 -21,145 0 -21,145 8,458 -12,687 -8,170
10 89,542 89,542 -35,817 53,725 34,595
10 -465,620 -465,620 -299,826
11 -11,390 -18,625 -30,015 93,124 -123,139 49,256 19,241 11,856
12 -12,073 -18,625 -30,698 148,998 -179,696 71,878 41,180 24,282
13 -12,798 -18,625 -31,423 89,399 -120,822 48,329 16,906 9,540
14 -13,565 -18,625 -32,190 53,639 -85,829 34,332 2,142 1,157
15 -14,379 -18,625 -33,004 53,639 -86,643 34,657 1,653 854
16 -15,242 -18,625 -33,867 26,820 -60,687 24,275 -9,592 -4,743
17 -16,157 -18,625 -34,782 0 -34,782 13,913 -20,869 -9,875
18 -17,126 -18,625 -35,751 0 -35,751 14,300 -21,451 -9,713
19 -18,154 -18,625 -36,779 0 -36,779 14,712 -22,067 -9,562
20 -19,243 -18,625 -37,868 0 -37,868 15,147 -22,721 -9,421
20 160,357 160,357 -64,143 96,214 39,894
* ATCF(R$) = ATCF(A$) × 1/(1.045)k
. − 0.045
012
ir = = 0.0718 or 7.18% per year
1.045
20 20
PW = ∑ ATCF (A$) (P/F, 12%, k) = ∑ ATCF (R$) (P/F, 7.18%, k) = −$359,665
k=0
k
k=0
k
602
Solutions to Case Study Exercises
A1[1 − ( P / F ,8%,5)( F / P,4%,5)]

8-52 PW(maintenance costs) =
0.08 − 0.04
= A1 (4.29785)
where A1 = $1,000 for the induction motor and A1 = $1,250 for the synchronous motor.
A1[1 − ( P / F ,8%,5)( F / P,5%,5)]

PW(electricity costs) =
0.08 − 0.05
= A1 ( 4.37834 )
PWTC(induction motor) = $17,640 + $1,000(4.29785) + $50,552(4.37834)

= $17,640 + $4,298 + $221,334
= $243,272
PWTC(synchronous motor) = $24,500 + $1,250(4.29785) + $55,950(4.37834)

= $24,500 + $5,372 + $244,968
= $274,840
PWTC(A) = (3)($243,272) + [$17,640 + $4,298 + (350/400)($221,334)]

= $945,421
PWTC(B) = (3)($274,840) + [$24,500 + $5,372 + (50/500)($244,968)]

= $878,889
PWTC(C) = (3)($243,272) + [$24,500 + $5,372 + (350/500)($244,968)]

= $931,166
PWTC(D) = (3)($274,840) + [$17,640 + $4,298 + (50/400)($221,334)]

= $874,125
Option (D) has the lowest present worth of total costs. Thus, the recommendation is still to power the
assembly line using three 500 hp synchronous motors operated at a power factor of 1.0 and one 400 hp
induction motor.
603
A1 [1 − ( P / F ,8%,8)( F / P,6%,8)]
8-53 PW(electricity costs) =
0.08 − 0.06
= A1 (6.9435)
PWTC(induction motor) = $17,640 + $1,000(6.5136) + $50,552(6.9435)

= $17,640 + $6,514 + $351,008
= $375,162
PWTC(synchronous motor) = $24,500 + $1,250(6.5136) + $55,950(6.9435)

= $24,500 + $8,142 + $388,489
= $421,131
PWTC(A) = (3)($375,162) + [$17,640 + $6,514 + (350/400)($351,008)]

= $1,456,772
PWTC(B) = (3)($421,131) + [$24,500 + $8,142 + (50/500)($388,489)]

= $1,334,884
PWTC(C) = (3)($375,162) + [$24,500 + $8,142 + (350/500)($388,489)]

= $1,430,070
PWTC(D) = (3)($421,131) + [$17,640 + $6,514 + (50/400)($351,008)]

= $1,331,423
Option (D) has the lowest present worth of total costs. Thus, the recommendation is still to power the
assembly line using three 500 hp synchronous motors operated at a power factor of 1.0 and one 400 hp
induction motor.
604
8-54 The following four options will be considered:
(A) Four induction motors (three at 400 hp, one at 100 hp)
(B) Three synchronous motors (two at 500 hp, one at 300 hp)
(C) Three induction motors at 400 hp plus one synchronous motor at 100 hp
(D) Two synchronous motors at 500 hp plus one induction motor at 300 hp.
PWTC(A) = (3)($364,045) + [$17,640 + $6,514 + (100/400)($339,891)]

= $1,201,262
PWTC(B) = (2)($408,827) + [$24,500 + $8,142 + (300/500)($376,185)]

= $1,076,007
PWTC(C) = (3)($364,045) + [$24,500 + $8,142 + (100/500)($376,185)]

= $1,200,014
PWTC(D) = (2)($408,827) + [$17,640 + $6,514 + (300/400)($339,891)]

= $1,096,726
Option (B) has the lowest present worth of total costs. Thus, the recommendation is to power the
assembly line using three 500 hp synchronous motors: two operated at 500 hp and one at 300 hp.
605
Solutions to FE Practice Problems
5, 200 − 3, 200(1 + 0.08) 4

8-55 % increase in cost =
3, 200
= 26.45%
Select (a)
606
8-56 ir = 0.06, f = 0.08
im = 0.06 + 0.08 + (0.06)(0.08)
= 0.1448 = 14.48%
Select (b)
607
8-57 By using Equation (8-1), we have R$ = $1(P/F, 2.4%, 44) = $0.3522.
Select (b)
608
8-58 A$ Analysis: im – 0.098 + 0.02 + (0.098)(0.02) = 0.12 or 12%
PWA(12%) = −$27,000 + $4,000(P/A,12%,5) = −$2,581

PWB(12%) = −$19,000 + $5,000(P/A,12%,5) = −$976
Neither alternative is acceptable.
Select (c)
609
8-59 A1 = $25,000 (1.04) = $26,000
$26,000[1 − ( P / F ,7%, ∞)( F / P,4%, ∞ ]

PW =
0.07 − 0.04
$26,000 ⎡ (1.04) ∞ ⎤
= ⎢1 − ∞ ⎥
0.03 ⎣ (1.07) ⎦
0
= $866,667
Select (a)
610
8-60 ($1.60 Canadian/Euro)($0.75 US/$1.00 Canadian) = $1.20 US/Euro
Select (c)
611
8-61 $1 U.S. = 0.75 Euro
$67 U.S. = 67 (0.75) = 50.25 Euro
Select (b)
612

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Solutions to Chapter 8 Problems

(a) f = 6% per year; ir = 4% per year

PW(ir) = $1,000 (P/A,4%,10) = $8,111

5% + 10% + (5%)(10%) = 15.5% per year.

PW0 = $12,262.36 (P/F, 15.5%, 2) = $9,192.

EOY Project A Project B

A($) (P/F, fr, k–b) R($) (Real $) at b = 0

1 100,000 0.9615 $96,150 $80,000

2 112,000 0.9246 $103,555.2 $100,000

3 136,000 0.8890 $120,904 $120,000

4 150,000 0.2548 $128,220 $140,000

Project B has least negative equivalent worth.

(a) (1+i)60 = 10 ⇒ i = 3.91% per year

(b) (1+i)60 = 50 ⇒ i = 6.73% per year

Effective interest rate = 6.73 – 3.91 = 2.82%

Total Capital Investment = $16,350,060 (1 + 0.05 + 0.042 + 0.08 + 0.31)

PW(12%) = −$24,230,790 – ($5)(125,000 ft2)

AW(4%) = −$28,584,102 (A/P,4%,10) = −$3,524,420

(b) R$20 = $60,700(P/F, 6%, 20) = $18,926.50

(c) $10,000(1 + ir)20 = $18,926.50

(d) P2 = $10,000(1 – 0.18)(1 – 0.33) = $5,658

P(1.05)20 = $400,000(1.07)20 or P = $400,000(1.07 / 1.05)20.

(c) C2015 = ($3.12 billion)(F/P, 9.2%, 10) = $7.52 billion

(b) $850 = $690(1.032)N; N = 6.62 years

(c) $285.56 = $850(1 + ir)28; ir = −3.82%

(b) Because im = f , P2020 = 4($35,949) = $143,796

(b) Left to student.

im = 0.1005 + 0.045 + (0.1005)(0.045) = 0.15 or 15% per year

iCR = (0.15 − 0.063) / 0.063 = 0.0818 or 8.18% per year

MV7 = (0.15)($838,000) = $125,700

PW(15%) = −$838,000 − $92,600(P/A, 8.18%, 7) + $125,700(P/F, 15%, 7) = −$1,269,908

Annual Revenue = $1,269,908 (A/P, 15%, 7) = $305,286

EOY BTCF Depreciation Taxable income Taxes (40%) ATCF

1 –500 +2,000 –2,500 1,000 500

2 –550 3,200 –2,750 1,100 550

3 –610 1,920 –2,530 1,012 402

4 –671 1,152 –1,823 729.2 58.2

5 –738.1 1,152 –1,890.1 756.04 17.94

6 –811.91 576 –1,387.91 555.164 –256.74

EOY BTCF Depreciation Taxable Tax (40%) ATCF

1 –200 +2,400 –2,600 1,040 840

2 –220 +3,840 –4,060 1,629 1,409

3 –242 2,304 –2,546 1,018.4 776.4

4 –266.2 1,382.4 –1,648.6 659.44 393.29

5 –292.82 1,382.4 –1,675.22 670.08 377.26

6 322.10 691.4 –322.791 129.11 –192.99

(A) (B) Taxable Cash Flow

PW1(20%) = −$X + $0.1133X(P/A,20%,3)

(A) (B) Taxable Cash Flow

PW2(20%) = −$13,200(P/F,20%,1) − $14,520(P/F,20%,2) − $15,972(P/F,20%,3)

Set PW1 = PW2 and solve for X.

−$X + $0.1133X(P/A,20%,3) = −$30,326

if m = ius + f e + f e (ius ) = 0.2 + 0.08 + 0.08 × 0.2

if m = 0.2 − 0.05 − 0.05 × 0.2 = 14%

Project is not economically acceptable.

By linear interpolation, i'% = IRRfm = 0.2798, or 28.0% per year.

Note: This confirms our recommendation in part (a).

(A) (B) (C) (D) (E) (F) (G)

(b) im = (1.05)(1.09524) – 1 = 0.15 = 15% per year

PW = −$50,640(P/F,15%,1) − $38,904(P/F,15%,2) − $33,194(P/F,15%,3)

EUAC = $146,084(A/P,15%,6) = $38,595

Cost of new finance

A($) = $800(1 + 0.05)10 = $13, 013.11

Annual maintenance expenses: A, (A$) = $200(1.05) = $210