Contemporary Engineering Economics 6th Edition by Chan Park

Exercise 3

A chemical plant is considering purchasing a computerized control system. The initial cost is $200,000, and the system will produce net savings of $100,000 per year. If purchased, the system will be depreciated under MACRS as a five-year recovery property. The system will be used for four years, at the end of which time the firm expects to sell it for $30,000. The firm's marginal tax rate on this investment is 35%. Any capital gains will be taxed at the same income tax rate. The firm is considering purchasing the computer control system either through its retained earnings or through borrowing from a local bank. Two commercial banks are willing to lend (he $200,000 at an interest rate of 10%. but each requires different repayment plans (Table). Bank A requires four equal annual principal payments with interest calculated on the basis of the unpaid balance. Bank B offers a payment plan, with five equal annual payments.
(a) Determine the cash flows if the computer control system is to be bought through its retained earnings (equity financing).
(b) Determine the cash flows if the asset is financed through either bank A or bank B.
(c) Recommend the best course of financing the project. (Assume that the firm's MARR is known to be 10%.)
Table