Question

5. (20 points) Office Automation, Inc., is obliged to choose between two copiers, XX40 or RH45. XX40 costs less than RH45, but its economic life is shorter. The costs and maintenance expenses of these two copiers are given as follows. These cash flows are expressed in real terms.

Answer 1

Answer 5) The decision can be taken on the basis of Present worth valuation of the both option

Present worth =PV ( annual cost)+Buying cost

Discounting rate = 14%

Copier	Year 0	1	2	3	4	5
XX40	-700	-100	-100	-100
Present value	-700	-87.7193	-76.9468	-67.4972
Net present cost	-932.163
RH45	-900	-110	-110	-110	-110	-110
Present value	-900	-96.4912	-84.6414	-74.2469	-65.1288	-57.1306
Net present Cost	-1155.38

Net present cost for RH45 is higher than XX40, we should buy XX40.

Answer 6) The discounting rate for PC business IBM as reference i.e. WACC of IBM  

For WWE, D/E= 0.7 , weight of equity = 1/1.7 = 0.588

Weight of debt = 1-0.588 = 0.412

Cost of debt = 12%

Net cost of debt = 12%*(1-34%)=7.92%

Cost of equity = 8+5 = 13%

WACC for WWE = 10.91%

for IBM , D/E= 0.4  weight of equity = 1/1.4 = 0.7143

Weight of debt = 1-0.588 = 0.2857

Cost of debt = 10%

Net cost of debt = 10%*(1-34%)=6.60%

Cost of equity = 8+5 = 13%

WACC for IBM = 11.17%