Problem 1

Year
($)
New Cmputer costs
ITC
Orginal cost of Old Computer
Book Value of Old computer
Old Computer can be sold for
Cost of Capital
Tax rate
Loss in Incurred after sale
a)
Net Investment Required =

1,000,000.00
15%
1,250,000.00
500,000.00
450,000.00
12%
35%
50,000.00

532,500.00

$
$
$

The write-off is worth

$
This reducres the effective investment in the new machine.
b)
Year
Forcast s net before tax
Tax @35%
Profit After tax
(+) Incremental Depreciation
Working Capital Capture
Cash Flow

Incremental cash flow =

Incremental depreciation calculayion is as below:

Cost

5 yr life, SL

17,500.00

(1,250,000.00)
790,000.00

1,250,000

Old Machine D/E

per year, 3 yrs old
250,000

c) If the new computers salvage value at the end of five years is projected to be $100,000,
should TelCo purchase it?
Answer
If the computer has a salvage value after 5 years, and is sold at that time, the book
value will be zero, and the company will have to pay a tax of 0.35 * 100 = $35 at that time.
This changes the marginal cash flow in five years to
The present value of the marginal cash flows (at 12%) is $899.19. The net present value is
899.19 - 532.50 = $366.70.
therefore, the new computer should be purchased.

1
350,000.00

2
350,000.00

3
300,000.00

4
300,000.00

5
300,000.00

1
350,000 $
122,500
227,500
(50,000)

2
350,000 $
122,500
227,500
(50,000)

3
300,000 $
105,000
195,000
(50,000)

4
300,000 $
105,000
195,000
(50,000)

5
300,000
105,000
195,000
(50,000)

177,500

177,500

145,000

145,000

145,000

1,000,000

New Machine
D/E per year Incremental
200,000
(50,000)

ojected to be $100,000,

time, the book

* 100 = $35 at that time.
330

The net present value is

Problem 3
Sales in units
100,000
Unit cost
$10
Varico offered to pay/unit
$9.50
Interest rate
15%
Total cost @ $9.50 per unit
$950,000.00
Total cost @ $10 per unit
$1,000,000.00
By buying 100,000 motors today, the firm will have average
inventory on hand of 50,000 during the year
50,000
The opportunity cost of maintaining this inventory equals $
71,250.00
By buying weekly, the firm incurs no interest expense
Thus, the real cost of buying 100,000 motors today is
$1,021,250.00
This exceeds the $1M that it costs to buy motors @ $10 a piece on weekly basis
therefore verico should reject the offer.
Difference
$
(21,250.00)

PROBLEM 4
Item
Equipment Cost (000)
$1,250
Depreciation
10%
Installation cost today (000) $25
Cost of Capital
10%
Tax rate
35%
Initial cost (000)
$875
i) Calculate the net income and operating cash flow using 35%
Year
Sales (000)
COGs (000)
Gross Margin (GM)
Adv and Gen. Ex (000)
Depreciation (Equip.) (000)
Depreciation (Install.) (000)
EBIT
Tax @ 35%
Net Income
OCF
PV @ (r = 10%)

1
200
120
80
10
$125
$5
(60)
(21)
(39)
91
83

2
1,000
600
400
10
$125
$5
260
91
169
299
247

3
1,150
690
460
10
$125
$5
320
112
208
338
254

4
1,323
794
529
10
$125
$5
389
136.15
253
383
261

Tax rate @35% Total PV =$ 2,120

ii) b. Find the net present value of the project using a 10 percent cost of capital.
Solution
Cost today =
$1,844
NPV =
$
276
The Project should be accepted
iii) Under the new cash flow estimates, the project should rejected as indicated below:
Year
Sales (000)
COGs (000)
Adv and Gen. Ex (000)

1
200
120
10

2
1000
600
11

3
1,150
720
11

4
1,323
864
12

Depreciation (Equip.) (000)

Depreciation (Install.) (000)
EBIT
Tax @ 35%
Net Income
OCF
PV @ (r = 10%)
Tax rate =
Total PV $(000) =
NPV $(000) =

$125
$5
($60)
($21)
($39)
$91
$83
35%
$1,760
($84)

$125
$5
$260
$91
$169
$299
247

$125
$5
$289
$101
$188
$318
239

$125
$5
$317
$111
$206
$336
229

5
1,521
913
608
10
$125
$5
468
163.92
304.43
434
270

6
1,749
1,049
700
10
$125
$0
565
197.61
366.99
492
278

7
1,749
1,049
700
10
$125
$0
565
197.61
366.99
492
252

8
1,487
892
595
10
$125
$0
460
160.88
298.78
424
198

9
1,264
758
505
10
$125
$0
370
129.66
240.80
366
155

10
1,074
644
430
10
$125
$0
295
103.13
191.52
317
122

6
1,749
1244
13

7
1,749
1244
13

8
1,487
1058
14

9
1,264
899
15

10
1,074
764
16

st of capital.

s indicated below:
5
1,521
1037
12

$125
$5
$342
$120
$222
$352
219

$125
$0
$367
$129
$239
$364
205

$125
$0
$367
$128
$238
$363
186

$125
$0
$290
$101
$188
$313
146

$125
$0
$225
$79
$146
$271
115

$125
$0
$170
$59
$110
$235
91