# Exam #2 Review Packet Solution **note because of the formatting I used in MS Excel decimals are not visible.

You are a business manager and are trying to decide whether to undertake one of two contracts or neither one. You were going to go with your gut feeling, but you have to give a presentation to your director and document why you chose the specific contract. After counseling your industrial engineering staff on the alternatives they have provided you with the following statistics. Which one contract is better?

Solution:

** note that the probabilities show up because I used the improper format in MS Excel Conclusion: E(NPW1) > E(NPW2) Var(NPW1) >Var(NPW2) Choose contract A because E(NPW1) > E(NPW2) and even though variation is project B is lower, with Project A there is no chance of going negative. What is the joint probability NPWA> NPWB = sum ( .2*.3 + .2*.4 + .2 *.3) + sum (.4*.3 + .4*.4 + .4*.3) + .4(.3) = .72 chance A is greater than B Joe s grandfather made an annual income of \$5,000 in 1930 as a mechanic. To follow in his grandfather s footsteps Joe has become a mechanical engineer and makes an average income of \$60,000 in 2010 (80 year difference). Assume inflation is an average of 3.5% per year and inflation-free interest is 4% per year. If assumed actual dollars for each year (1930 & 2010) - what are the actual dollar amounts for each individual in these years?

Grandpa ; Joe In 1930 - \$5,000 ; \$3,287.57 In 2010 - \$78,378.69 ;\$60,000 What is the market interest rate for this example?    If Joe s grandfather had managed to save \$2,000 by the time he was done working in 1935 and put it in a savings account earning market interest rate how much would it be worth in 2010? FV(.0764, 75, 0, 2000) = \$500,099.80 Considering the following information: I = \$20,000 , N = 5 , and Salvage = 0 Find book value (Bn) for each year using straight-line method, double declining, and the DDB-to-SL

(Switch to SL in period 4) Austin decided to buy his first house on November 21, 2004 in the residential district for \$250,000. The house was valued at \$200,000 for the house and \$50,000 for the land. However, because he invested all his earnings in high-risk stocks the recession of 2006 forced him to sell his home on February 12th, 2007 for extra money. He sold his home for \$220,000 including the land still valued at \$50,000. How much tax depreciation can he take off in the first year?

How much depreciation did he remove in all of his years of owning the home?

Did he gain money or lose money on the sale of the home? And assuming gain/loss taxes are 34% how much can he either claim or owe? Value = 200,000-16,363.64 = 183,636.36 + 50,000 land = 233,636.36 Loss = 220,000 233,636.36 = (-\$13636.36) Tax credit=\$13,636.36 * .34 = \$4,636.36 Influenced by her friends to start her own business, Claire purchased a used CNC machine to create her new product in May 2004 for \$40,000. The CNC machine is classified as a 5-year MACRS class property. It cost an additional \$5,000 to level the floor in her garage with new cement before the machine arrived. Because of the rapid success of her business, she sold her equipment for \$20,000 in July 2007 in order to purchase state-of-the-art machinery and move into a production facility. If Claire didn t sell her CNC machine what are the values for depreciation in all years? Total investment = \$40,000 (machine) + \$5,000 (site-prep)

Because Claire did sell her machine, what was the book value in 2007?

Equation: BV = 45,000 * (1 (.2 + .32 + .1920 + .1152/2) = \$10,368 What are her gains taxes assuming 34%? Gains: \$20,000 - \$10,368 = \$9,632 Gains Taxes: \$9,632 * .34 = \$3,274.88

If her small business profit in 2004 was \$30,000 and federal taxes were 15% and State of Iowa taxes were 7% how much in total would she pay to both federal and state governments? Combined tax rate = .15 + .07 - .15*.07 = .2095 Taxes = \$6,285 Below is a chart of the CPI vs. cost of college tuition

If the CPI in 2000 is 250 and in 2010 is 380 what is the general inflation rate during these years? 375 = 250 (1 + f)^10 F = 4.138% If the college tuition CPI is 800 in 2005 and 1,050 in 2010 what is the general inflation rate during these years? 1050 = 800 (1+f)^5 F = 5.589% If college tuition CPI continues to rise at the general inflation rate what will the college tuition be in 2020 assuming it is 1,050 in 2010. = FV(.0559,10,0,1050) = 1809 Once again you are in an engineering position in which you want to impress your boss at an electronic facility. You have done the cost-savings report for a new chip shooting machine that will reduce the time to load circuit boards on the assembly line. Below is the information you have gathered from several sources.

y y y y y y y y

The chip shooting machine will cost \$1,200,000 and will depreciate by the 5-year MACRS The machine will save \$200,000 in labor each year, but will cost you an additional \$25,000 in maintenance upkeep The facilities department have concluded an extra \$25,000 per year in electricity will be used In addition, you receive a statistics quality report from the industrial engineer explaining the machine will reduce scrap equating to an expected savings of \$300,000 per year The cost of installation will be an additional \$50,000 An estimated value of salvage value is 100,000 after 7 years Finance has confirmed the electronic facility operates at a high MARR of 15% and income tax/gains tax level of 40% Finance also explained that they would want to finance the loan of \$1,200,000 at an interest rate of 5% annually

Assuming you make 5 equal payments to pay off the machine with a 5% interest rate, what are your yearly payments for the chip shooting machine. A = P(A/P, 5%, 5) = \$277,169.76 Fill in the table loan repayment schedule below

What is the MACRS schedule for tax depreciation over the next 7 years?

Fill in the income statement and cash flow items on the next page and justify whether or not to invest in the machine

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