Exam 10: Developing Project Cash Flows

You are considering purchasing industrial equipment to expand one of your production lines. The equipment costs $100,000 and has an estimated service life of 6 years. Assuming that the equipment will be financed entirely from your business-retained earnings (equity funds), a fellow engineer has calculated the expected after tax cash flows, including the salvage value, at the end of its project life are as follows: Now you are pondering the possibility of financing the entire amount by borrowing from a local bank at 12% interest. You can make an arrangement to pay only the interest each year over the project period by deferring the principal payment until the end of 6 years. Your firm's interest rate is also 12%. The expected marginal income tax rate over the project period is known to be 40%. What is the amount of economic gain (or loss) in present worth by using debt financing over equity financing?

A special purpose machine tool set would cost $20,000. The entire capital expenditure ($20,000) is to be borrowed with the stipulation that it be repaid by 2 equal end-of-year payments at 10%, compounded annually ( or $11,524 per year). The tool is expected to provide annual savings (material) of $35,000 for 2 years and is to be depreciated by the MACRS 3-year recovery period. And this special machine tool will require annual O&M costs in the amount of $5,000. The salvage value at the end of 2 years is expected to be $6,000. The project requires an investment in working capital in the amount of $3,000, but the entire amount will be recovered at the end of project life. Assuming a marginal tax rate of 40% and MARR of 15%, what is the net present worth of this project?

Which of the following statements is most correct?

Consider the following financial data for an investment project:

Oxford Manufacturing Company needs an air compressor and has narrowed the choice to two alternatives, A and B. The following financial data have been collected: (a) Select Model A because you can save $440 annually. (b) Select Model A because its incremental rate of return (Model A - Model B) exceeds 20%. (c) Select Model A because you can save $1,845 in present worth. (d) Select Model A because its incremental rate of return (Model B - Model A) is 14.12%, which is less than

A corporation is considering purchasing a machine that will save $200,000 per year before taxes. The cost of operating the machine, including maintenance, is $80,000 per year. The machine costing $150,000 will be needed for 5 years, after which it will have a salvage value of $25,000. A straight-line depreciation with no half-year convention applies (i.e., 20% each year). If the firm wants 15% rate of return after taxes, what is the net present value of the cash flows generated from this machine? The firm's income tax rate is 40%.

Lane Construction Ltd. is considering the acquisition of a new eighteen-wheeler. • The truck's base price is $80,000, and it will cost another $20,000 to modify it for special use by the company. • This truck falls into the MACRS five-year class. It will be sold after three years for $30,000. • The truck purchase will have no effect on revenues, but it is expected to save the firm $45,000 per year in before-tax operating costs, mainly in leasing expenses. • The firm's marginal tax rate (federal plus state) is 40%, and its MARR is 15%. (a) Is this project acceptable, based on the most likely estimates given in the problem? (b) If the firm's MARR is increased to 25%, what would be the required savings in leasing so that the project would remain profitable?

You are planning to lease an automobile for 36 months from a local dealer. The negotiated price is $20,000. The required security deposit is $500 at the time of the lease and will be refunded in full at the end of the lease. The monthly lease payable at the end of each month is calculated to be $300. The dealer will depreciate the asset over five years with a salvage value of 10% of the original purchase price. What kind of residual value (salvage value) was assumed by the dealer in calculating the monthly lease? The dealer's after-tax interest rate is known to be 9%, compounded monthly. Assume that the dealer's tax rate is 35%.

Cutter Ltd. is planning to invest $150,000 in an automated screw-cutting machine to enhance its current operations. Due to a lack of internal funds, its management is planning to borrow 60% of the investment from a local bank at an interest rate of 10% payable in 5 equal payments. What is the principal payment in year 2 that should be included in the after-tax cash flow analysis?