The Target Copy Company is contemplating the
replacement of its oldprinting machine with a new model costing
$60,000. The old machine, which
originally cost $40,000, has 6 years of expected life remaining and a current
book value of $30,000 versus a current market value of $24,000. Target’s corporate tax rate is 40 percent. If
Target sells the old machine at market value, what is the initial after-tax
outlay for the new printing machine?
a. -$22,180
b. -$30,000
c. -$33,600
d. -$36,000
e. -$40,000
[i]. Dandy
Product’s overall weighted average required rate of return is 10 percent. Its
yogurt division is riskier than average, its fresh produce division has average
risk, and its institutional foods division has below-average risk. Dandy
adjusts for both divisional and project risk by adding or subtracting 2
percentage points. Thus, the maximum adjustment is 4 percentage points. What is
the risk-adjusted required rate of return for a low-risk project in the yogurt
division?
a. 6%
b. 8%
c. 10%
d. 12%
e. 14%
Medium:
[MACRS table required]
[ii]. Mars
Inc. is considering the purchase of a new machine which will reduce
manufacturing costs by $5,000 annually.
Mars will use the MACRS accelerated method to depreciate the machine,
and it expects to sell the machine at the end of its 5-year operating life for
$10,000. The firm expects to be able to
reduce net operating working capital by $15,000 when the machine is installed,
but required working capital will return to the original level when the machine
is sold after 5 years. Mars’s marginal
tax rate is 40 percent, and it uses a 12 percent cost of capital to evaluate
projects of this nature. If the machine
costs $60,000, what is the project’s NPV?
a. -$15,394
b. -$14,093
c. -$58,512
d. -$21,493
e. -$46,901
[MACRS table required]
[iii]. Stanton
Inc. is considering the purchase of a new machine which will reduce
manufacturing costs by $5,000 annually and increase earnings before
depreciation and taxes by $6,000 annually.
Stanton
will use the MACRS method to depreciate the machine, and it expects to sell the
machine at the end of its 5-year operating life for $10,000 before taxes. Stanton’s
marginal tax rate is 40 percent, and it uses a 9 percent cost of capital to
evaluate projects of this type. If the
machine’s cost is $40,000, what is the project’s NPV?
a. $1,014
b. $2,292
c. $7,550
d. $ 817
e. $5,040
[iv]. Parker Products
manufactures a variety of household products. The company is considering
introducing a new detergent. The
company’s CFO has collected the following information about the proposed
product. (Note: You may or may not need
to use all of this information, use only the information that is relevant.)
·
The project has an anticipated
economic life of 4 years.
·
The company will have to
purchase a new machine to produce the detergent. The machine has an up-front cost (t = 0) of
$2 million. The machine will be depreciated on a straight-line basis over 4
years (that is, the company’s depreciation expense will be $500,000 in each of
the first four years (t = 1, 2, 3, and 4).
The company anticipates that the machine will last for four years, and
that after four years, its salvage value will equal zero.
·
If the company goes ahead with
the proposed product, it will have an effect on the company’s net operating
working capital. At the outset, t = 0,
inventory will increase by $140,000 and accounts payable will increase by
$40,000. At t = 4, the net operating
working capital will be recovered after the project is completed.
·
The detergent is expected to
generate sales revenue of $1 million the first year (t = 1), $2 million the
second year (t = 2), $2 million the third year (t = 3), and $1 million the
final year (t = 4). Each year the
operating costs (not including depreciation) are expected to equal 50 percent
of sales revenue.
·
The company’s interest expense
each year will be $100,000.
·
The new detergent is expected
to reduce the after-tax cash flows of the company’s existing products by
$250,000 a year (t = 1, 2, 3, and 4).
·
The company’s overall WACC is
10 percent. However, the proposed
project is riskier than the average project for Parker; the project’s WACC is
estimated to be 12 percent.
·
The company’s tax rate is 40
percent.
What is the net present
value of the proposed project?
a.
-$ 765,903.97
b. -$1,006,659.58
c. -$
824,418.62
d. -$
838,997.89
e. -$
778,583.43
[v]. Virus
Stopper Inc., a supplier of computer safeguard systems, uses a cost of capital
of 12 percent to evaluate average-risk projects, and it adds or subtracts 2
percentage points to evaluate projects of more or less risk. Currently, two
mutually exclusive projects are under consideration. Both have a cost of
$200,000 and will last 4 years. Project A, a riskier-than-average project, will
produce annual end of year cash flows of $71,104. Project B, of less than
average risk, will produce cash flows of $146,411 at the end of Years 3 and 4
only. Virus Stopper should accept
a. B
with a NPV of $10,001.
b. Both
A and B because both have NPVs greater than zero.
c. B
with a NPV of $8,042.
d. A
with a NPV of $7,177.
e. A
with a NPV of $15,968.
%.
