Chapter 11 Homework Problems

Assignment: From chapter 11 in the 5th or chapter 10 in the 4th edition of the book work problems
9 (the salvage value for depreciation and the market value at the end are both $0; for part b
calculate IRR instead of PI) and problem 15 plus the following two problems.
9.2.

The Ewert Company is evaluating the proposed acquisition of a new milling machine.
The machines base price is $108,000, and it would cost another $12,500 to modify it for
special use by the firm. The machine falls into the MACRS three-year class, and it would
be sold after three years for $65,000. (Use the MACRS depreciation percentages that we
have been using: 33%, 45%, 15% and 7%.) The machine would require an increase in
net working capital (inventory) of $5,500. The milling machine would have no effect on
revenues, but it is expected to save the firm $44,000 per year in before-tax operating
costs, mainly labor. Ewerts marginal tax rate is 34 percent.
a. What is the initial investment outlay of the machine for capital budgeting purposes?
(That is, what is the Year 0 net cash flow?)
b. What are the incremental operating cash flows in years 1, 2, and 3?
c. What is the terminal cash flow in Year 3?
d. If the projects required rate of return is 12 percent, should the machine be
purchased?

9.4.

The Boyd Bottling Company is contemplating the replacement of one of its bottling
machines, with a newer and more efficient one. The old machine currently has a book
value (basis) of $600,000 and a remaining useful life of five years. The firm does not
expect to realize any return from scrapping the old machine in five years, but it can sell it
now to another firm in the industry for $265,000. The old machine is being depreciated
toward a zero salvage value, by $120,000 per year, using the straight-line method.
The new machine has a purchase price of $1,175,000, an estimated useful life and
MACRS class life of five years, and an estimated market value of $145,000 at the end of
five years. (MACRS 5-year class life recovery allowance percentages are 20%, 32%,
19%, 12%, 11%, and 6%.)
It is expected to economize on electric power usage, labor, and repair costs, which will
save Boyd $230,000 each year. In addition, the new machine is expected to reduce the
number of defective bottles, which will save an additional $25,000 annually. The
companys marginal tax rate is 40 percent and it has a 12 percent required rate of return.
a. What initial investment outlay is required for the new machine?
b. Calculate the annual depreciation allowances for both machines, and compute the
change in the annual depreciation expense if the replacement is made.
c. What are the incremental operating cash flows in Years 1 through 5?
d. What is the terminal cash flow in Year 5?
e. Should the firm purchase the new machine? Support your answer.

On the next page is a table format for working these problems. You may want to print multiple
copies.
1

Initial Outlay

Depreciation [initial basis =

Work space

Operating Cash flow

minus
deprec.
EBT
less taxes
EAT
Dep. addback

OCF
Terminal CF

Timeline and calculator inputs/outputs and investment decision

TCF workspace