Chapter 11 Homework Problems
Assignment: Two problems from the textbook (see the assignment web page) plus the following two problems.
9.2.The Ewert Company is evaluating the proposed acquisition of a new milling machine. The machine’s 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. Ewert’s 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 project’s required rate of return is 12 percent, should the machine bepurchased?
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 company’s 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. add-back
OCF
Terminal CF / Timeline and calculator inputs/outputs and investment decision
TCF workspace
1