1. A company is considering a 4-year capital project. The original investment today is $52,000. The expected annual cash revenue minus cash expenses before taxes is $17,500 (in real terms). The original investment will be depreciated over 4 years to 0 at t=4 using the straight-line method. The real cost of capital is 8.0% and the income tax rate is 35%.
a. Calculate the net present value of this project if there is no inflation.
In real terms
b. Calculate the net present value of this project if inflation is 5.0% per year.
2. The Solti Company has determined that it needs a new truck for the delivery
of musical instruments. It is deciding between two competing trucks. One is
more expensive to buy but is sturdier and thus will have lower annual
operating costs and will last longer. You expect to have to replace these
trucks when their useful lives are over. You have the following data:
Truck A Truck B
Initial cost $20,000 $16,000
Life 7 years 5 years
After-tax annual operating
Expenses $4,500 $5,500
The company’s cost of capital (discount rate) is 10.0%.
Which of the two trucks would you select? Depreciation has already been
included in the above data, so ignore it. (Show all calculations)
3. You have a cellar filled with fine wines which you are keeping for resale at a
propitious time (you consume the cheaper wines). You expect the value of
these wines to increase over time as follows (after all costs):
Year 1 34,500
Year 2 39,000
Year 3 41,900
Year 4 44,400
Year 5 46,600
If your cost of capital is 8.0%, when would be the best time sell the wine?
4. A new machine has come on the market. It is considerably more efficient
than the old machine you now have on the factory floor. The old machine is expected to have 3 more useful years. When should you replace it? Here are the relevant data you need to make your decision:
Old machine: Original cost $10,000
Year Net after-tax cash inflow After-tax resale value
1 ` $6,000 2,000
2 5,000 1,000
3 4,000 0
The company can replace this machine with a new, more efficient machine at
a cost of $15,000. It would provide an after-tax cash flow of $8,000 per year,
and could be sold at the end of 3 years for $4,000 (after taxes).
The company’s cost of capital is 10.0%. When (if at all) should the company
replace the old machine? (Show all calculations.)
5. Joyce Silver owns Goodcomp, Inc. She expects after-tax profit per share to
be $3.00 in the forthcoming year. During years 2 through 5, she forecasts
that profit per share will grow by 12.0% each year. All profits will be reinvested in the business to support growth, so there will be no dividends. Starting in year 6, she forecasts that profit growth will fall to 7.0% per year for the foreseeable future, and that the company will need to reinvest only 70% of earnings, paying out the rest in dividends. The Golden Computer Company has recently offered Silver $18 per share for her company. Should Silver sell her stock if the appropriate required rate of return (cost of capital) is 11.0%?