Q:11-3

Allen Air Lines must liquidate some equipment that is being replaced.
The equipment
originally cost $12 million, of which 75% has been depreciated. The used
equipment can
be sold today for $4 million, and its tax rate is 40%. What is the
equipment’s after-tax net
salvage value?

Equuipment Cost
Less: Accumalated Deprication (75%)
Book Value

Salvage Value
Gain on disposal (S.V-B.V)
Tax in gain @ 40%

S.v Before Taxs

Less Tax

Q:11-4

Although the Chen Company’s milling machine is old, it is still in

relatively good working
order and would last for another 10 years. It is inefficient compared to
modern standards,
though, and so the company is considering replacing it. The new milling
machine, at a
cost of $110,000 delivered and installed, would also last for 10 years and
would produce
after-tax cash flows (labor savings and depreciation tax savings) of
$19,000 per year. It
would have zero salvage value at the end of its life. The firm’s WACC is
10%, and its
marginal tax rate is 35%. Should Chen buy the new machine?
Q:12-6

The Campbell Company is considering adding a robotic paint sprayer to

its
production line. The sprayer’s base price is $1,080,000, and it would cost
another
$22,500 to install it. The machine falls into the MACRS 3-year class, and
it would be
sold after 3 years for $605,000. The MACRS rates for the first three years
are 0.3333,
0.4445, and 0.1481. The machine would require an increase in net
working capital
(inventory) of $15,500. The sprayer would not change revenues, but it is
expected to
save the firm $380,000 per year in before-tax operating costs, mainly
labor.
Campbell’s marginal tax rate is 35%.
a. What is the Year 0 net cash flow?
b. What are the net operating cash flows in Years 1, 2, and 3?
c. What is the additional Year-3 cash flow (i.e., the after-tax salvage and
the return of
working capital)?
d. If the project’s cost of capital is 12%, should the machine be
purchased?

A)
BASE PRICE
Add: Install
Cost of M/c

Add: Inventory net operating

Year 0 Cash Flow

B)
Operating Cost
Tax Saving in operating cost (1-0.35)

Depriciable Cost
Depriciable rate
Depriciation
After Tax Saving in depriciation (0.35)

Add:Tax Saving in operating cost + After Tax Saving in depriciation

C)

Book Value (1-0.333+0.4445+0.1481)

Salvage Value
A.S, S.v>B.V
Gain on disposal

Tax Gain (35%)

Less Tax gain on salvage Value

Add: Return of NOW'C
Additional Cash Flow of Year 3

D)

Accept the Replacement Project Bcz NPV is positive

Q: 12-7
The president of the company you work for has asked you to evaluate
the proposed
acquisition of a new chromatograph for the firm’s R&D department. The
equipment’s
basic price is $70,000, and it would cost another $15,000 to modify it for
special use by
your firm. The chromatograph, which falls into the MACRS 3-year class,
would be sold
after 3 years for $30,000. The MACRS rates for the first three years are
0.3333, 0.4445, and
0.1481. Use of the equipment would require an increase in net working
capital (spare
parts inventory) of $4,000. The machine would have no effect on
revenues, but it is
expected to save the firm $25,000 per year in before-tax operating
costs, mainly labor. The
firm’s marginal federal-plus-state tax rate is 40%.

A)
Base Price
Add: Another Cost
Cost of M/C

Add: Net Operating

Year 0 Cash Flow

B)

Saving on operating cost

After Taxing saving in O.C (1-0.40)

Depriciation Cost
Depriciable Rate
Deprication

After Saving 40%

Add: After Tax Saving in O.C + After Tax Saving in Depriciation

C)

Book Value: (1- 0.9259) * 85,000

Salvage Value

A.S, B.V>S.V
So there is loss on disposal

Loss On Disposal

Tax on loss in 40%

Add: Non operatring Expenses

D)

Q:11-8

The Rodriguez Company is considering an average-risk investment in a

mineral water
spring project that has a cost of $150,000. The project will produce
1,000 cases of mineral
water per year indefinitely. The current sales price is $138 per case, and
the current cost
per case is $105. The firm is taxed at a rate of 34%. Both prices and costs
are expected to
rise at a rate of 6% per year. The firm uses only equity, and it has a cost
of capital of 15%.
Assume that cash flows consist only of after-tax profits, because the
spring has an
indefinite life and will not be depreciated

Sale Revenue: sale price * Produce of casses of minerals

Cost Revenue: Curent cost * produce of casses of mineral
Profit: Sales-Cost
Tax Rate
Net Profit

Year 0 Cash Flow

Cost of Machines
Net profit
Depriciable Cost

Saving in operating cost

Tax after saving in O.C (1-0.06)

Q: 12-9
The Gilbert Instrument Corporation is considering replacing the wood
steamer it
currently uses to shape guitar sides. The steamer has 6 years of
remaining life. If kept,
the steamer will have depreciation expenses of $650 for five years and
$325 for the sixth
year. Its current book value is $3,575, and it can be sold on an Internet
auction site for
$4,150 at this time. If the old steamer is not replaced, it can be sold for
$800 at the end
of its useful life.Gilbert is considering purchasing the Side Steamer 3000,
a higher-end steamer, which
costs $12,000 and has an estimated useful life of 6 years with an
estimated salvage value of
$1,500. This steamer falls into the MACRS 5-year class, so the applicable
depreciation
rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The new
steamer is faster
and allows for an output expansion, so sales would rise by $2,000 per
year; the new
machine’s much greater efficiency would reduce operating expenses by
$1,900 per year.
To support the greater sales, the new machine would require that
inventories increase by
$2,900, but accounts payable would simultaneously increase by $700.
Gilbert’s marginal
federal-plus-state tax rate is 40%, and its WACC is 15%. Should it replace
the old steamer?

Compute After-tax sale revenue increase as follows:

Q:11-10
St. Johns River Shipyard’s welding machine is 15 years old, fully
depreciated, obsolete, and
has no salvage value. However, even though it is obsolete, it is perfectly
functional as
originally designed and can be used for quite a while longer. A new
welder will cost
$182,500 and have an estimated life of 8 years with no salvage value.
The new welder will
be much more efficient, however, and this enhanced efficiency will
increase earnings
before depreciation from $27,000 to $74,000 per year. The new
machine will be
depreciated over its 5-year MACRS recovery period, so the applicable
depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and
5.76%. The applicable corporate tax rate
is 40%, and the firm’s WACC is 12%. Should the old welder be replaced
by the new one?
 12,000,000
9000000
3,000,000

4,000,000
1,000,000
400000
600,000

4,000,000
400,000
4,600,000

YEARS Total Benefit Discounted P.V.

0 -110,000 1 -110000
1 19,000 0.909090909 17272.7273
2 19,000 0.826446281 15702.4793
3 19,000 0.751314801 14274.9812
4 19,000 0.683013455 12977.2557
 5 19,000 0.620921323 11797.5051
6 19,000 0.56447393 10725.0047
7 19,000 0.513158118 9750.00425
8 19,000 0.46650738 8863.64022
9 19,000 0.424097618 8057.85475
10 19,000 0.385543289 7325.3225

NPV 6746.77501

1,080,000
22,500
1,102,500

15,500
1,118,000

YEAR 1 YEAR 2 YEAR 3

 380,000 380,000 380,000
0.65 0.65 0.65
247000 247000 247000

1,102,500 1,102,500 1,102,500

0.3333 0.4445 0.1481
367463.25 490061.25 163280.25
128612.1375 171521.4375 57148.0875

375612.1375 418521.4375 304148.0875

(1-0.9259) 1,102,500
81,695

605,000

523,305

183156.75

421,843
15,500
437,343

Year Cash Flow PVIF PV'S

0 -1,118,000 1 -1,118,000
1 375,612 0.892857143 335367.857
2 418,521 0.797193878 333642.379
3 741,491 0.711780248 527778.888
78,789
a. What is the Year-0 net cash flow?
b. What are the net operating cash flows in
Years 1, 2, and 3?
c. What is the additional (nonoperating) cash
flow in Year 3?
d. If the project’s cost of capital is 10%,
should the chromatograph be purchased?

70,000
15,000
85,000

4,000
89,000

Year 1 Year 2 Year 3

25,000 25,000 25,000
15000 15000 15000

85,000 85,000 85,000

0.3333 0.4445 0.1481
28330.5 37782.5 12588.5

11332.2 15113 5035.4

26332.2 30113 20035.4

6298.5
 30000

36298.5

14519.4

25,000
39,519

Year Cash flows PVIF'S PV'S

0 -89,000 1 -89000
1 26332.2 0.909090909 23938.3636
2 30113 0.826446281 24886.7769
3 20035.4 0.751314801 15052.8926
-25121.9669

a. Should the firm accept the project? (Hint:

The project is a growing perpetuity, so you
must use the constant growth formula to find
its NPV.)
b. Suppose that total costs consisted of a
fixed cost of $10,000 per year plus variable
costs of $95 per unit and only the variable
costs were expected to increase with
inflation. Would this make the project better
or worse? Continue to assume that the
sales price will rise with inflation.

138 * 1000 138000

105*1000 105000
33000
34% 11220
21780
 150,000
21,780
171,780

Year 1 Year 2 Year 3 Year 4 Year 5

21780 21780 21780 21780 21780
0.94 0.88 0.82 0.76 0.7
20473.2 19166.4 17859.6 16552.8 15246

Years Cash Flows PVIF PV

0 -171,780 1 -171780
1 20473.2 0.869565217 17802.7826
2 19166.4 0.756143667 14492.552
3 17859.6 0.657516232 11742.9769
4 16552.8 0.571753246 9464.11712
5 15246 0.497176735 7579.95651
-110697.615
Cash Flow at the year 0
Purchase Price 12,000
Sale of old machine 4,150 -7,850
Tax on sale of old machine @ 40% -3,140
Net Operating working Capital (-2900+700) -2200

Cash Flow at the year 0 -5,340

sales increases 2,000

cost decreases 1,900
Total increase in per revenue 3,900
less: Tax rate @ 40% 1560

After Tax revenue Increase 2,340

Depriciation Tax Saving:
YEARS 1 2 3 4 5

Machine Costs 12,000 12,000 12,000 12,000 12,000

Tax Rate 20% 32% 19.20% 11.52% 5.76%

Machine Depriciation as per Tax Rate 2400 3840 2304 1382.4 691.2

Less: Old Machine Depriciation -650 -650 -650 -650 -325

Change in Depriciation 1750 3190 1654 732.4 366.2

Depriciation Tax Saving At 40% 700 1276 661.6 292.96 146.48

Compute NPV:
Years 0 1 2 3 4
Net Investment -5,340
After Tax Sale reveneue increase @40% 2,340 2,340 2,340 2,340
Depriciation Tax Saving @ 40% 700 1276 661.6 292.96
Working Capital Recovery
After Tax salvaeg of new machine (1,500*1-0.40)
Opportunity Cost of Old Machine (800*1-0.40)

Project Cash Flows -5,340 2400 3840 2304 1382.4

PVF @ 14% 1 0.877192982 0.76946753 0.674972 0.59208
PV OF Cash Flow -5340 2105.263158 2954.75531 1555.134 818.4918

NPV OF Cash Flow 3424.4911753

Years 0 1 2 3 4
Equipment Cost -182,500

Depriciation before taxs (74,000-27,000) 47000 47000 47000 47000

Tax Rate (1-0.40) 0.6 0.6 0.6 0.6
Depriciation Rate after taxs 28200 28200 28200 28200

Tax Shield on Depriciation 21900 35040 21024 12614.4

Operating Cash Flow 50100 63240 49224 40814.4

Cost of Machine -81,000

Net Cash Flow -81,000 50100 63240 49224 40814.4
PVIF @ 12% 1 0.892857143 0.79719388 0.71178 0.635518

Present Value -81000 44732.14286 50414.5408 35036.67 25938.29

Net Present Value 139909.00664

 5

2,340
146.48
2,200
900
-480

691.2
1.925415
1330.847
 5 6 7 8

47000 47000 47000 47000

0.6 0.6 0.6 0.6
28200 28200 28200 28200

12614.4 6307.2 0 0
40814.4 34507.2 28200 28200

40814.4 34507.2 28200 28200

0.567427 0.506631 0.452349 0.403883

23159.19 17482.42 12756.25 11389.51