MB 2203 FINANCIAL MANAGEMENT

TUTORIAL WEEK 11A

1. Dave and Ann Stone have been living at their present home for the past 6 years. During that time,
they have replaced the water heater for $375, have replaced the dishwasher for $599, and have
had to make miscellaneous repair and maintenance expenditures of approximately
$1,500. They have decided to move out and lease the house for $975 per month. Newspaper
advertising will cost $75. Dave and Ann intend to paint the interior of the home and power- wash
the exterior. They estimate that that will run about $900.
The house should be ready to rent after that. In reviewing the financial situation, Dave views all
the expenditures as being relevant, and so he plans to net out the estimated expenditures
discussed above from the rental income.
a) Do Dave and Ann understand the difference between sunk costs and opportunity costs?
Explain the two concepts to them.
b) Which of the expenditures should be classified as sunk cash flows and which should be viewed
as opportunity cash flows?

2. For each of the following projects, determine the relevant cash flows, and depict the cash flows on
a timeline.
a) A project that requires an initial investment of $120,000 and will generate annualoperating
cash inflows of $25,000 for the next 18 years. In each of the 18 years, maintenance of the
project will require a $5,000 cash outflow.
b) A new machine with an installed cost of $85,000. Sale of the old machine will yield
$30,000 after taxes. Operating cash inflows generated by the replacement will exceed the
operating cash inflows of the old machine by $20,000 in each year of a 6-year period.At the
end of year 6, liquidation of the new machine will yield $20,000 after taxes, whichis $10,000
greater than the after-tax proceeds expected from the old machine had it beenretained and
liquidated at the end of year 6.

3. DuPree Coffee Roasters, Inc., wishes to expand and modernize its facilities. The installed cost of a
proposed computer-controlled automatic-feed roaster will be $130,000. The firm has a chance to
sell its 4-year-old roaster for $35,000. The existing roaster originally cost $60,000 and was being
depreciated using MACRS and a 7 years recovery period. DuPree is subject to a 40% tax rate.
a) What is the book value of the existing roaster?
b) Calculate the after-tax proceeds of the sale of the existing roaster.
c) Calculated the change in net working capital using the following figures:
Anticipated Changes
in Current Assets and Current Liabilities
Accruals - $ 20,000
Inventory + 50,000
Accounts payable + 40,000
Accounts receivable + 70,000
Notes payable + 15,000

d) Calculate the initial investment associated with the proposed new roaster.