Question

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15. Automated Manufacturers uses high-tech equipment to produce specialized aluminum products for its customers. Each one of these machines costs $1,480,000 to purchase plus an additional $52,000 a year to operate. The machines have a 6-year life after which they are worthless. What is the equivalent annual cost of one these machines if the required return is 16 percent? (a) -S453,657 (b) -$427,109 (c) -S301,586 (d)-S256,947 16. Precision Tool is analyzing two machines to determine which one it should purchase. The company requires a 15 percent rate of return and uses straight-line depreciation to a zcro book value over the life of its equipment. Machine A has a cost of $892,000, annual operating costs of $28,200, and a 4-year life. Machine B costs $1,118,000, has annual operating costs of $19,500, and has a 5-year life. Whichever machine is purchased will be replaced at the end of its useful life. Precision Tool should purchase Machine because it lowers the firm's annual cost by approximately other machine. as compared to the (a) A; S12,380 (b) B; S16,965 (c) A; $17,404 (d) B; $17,521 17. Phone Home, Inc. is considering a new 5-year expansion project that requires an initial fixed asset investment of S2.484 million. The fixed asset will be depreciated straight-line to zero over its 5-year tax life, after which time it will be worthless. The project is estimated to generate $2,208,000 in annual sales, with costs of S883,200. The tax rate is 32 percent and the required return on the project is 11 percent. What is the net present value for this project? (a) S1,432,155 (b) S1,433,059 (c) S1,434,217 (d) S1,435,008 18. A software company has just developed a new software suite. Which of the following cash flows should be treated as incremental when deciding whether to go ahead and produce the software? A. The research and development costs that were incurred developing the software. B. The value of land that you would otherwise sell. C. The consequent increase in the sales of the company's existing software products due to bundling of its D. The salvage value of the equipment at the end of its planned life. E. Tax shield associated with the software amortization charge F. Marketing expenses for the product. G. A proportion of expenses for the head office assuming these expenses are independent of whether software is produced. (a) A, B, C, D, E (b) B, D, E, F, G (c) B, C, D, E, F (d) A, C, D, E, F

Answer 1

15) a) -$453657

Statement showing Equivalent annual cost

Particulars	0	1	2	3	4	5	6	NPV
Cost of Machine	-1480000
Operating cost		-52000	-52000	-52000	-52000	-52000	-52000
Cash flow	-1480000	-52000	-52000	-52000	-52000	-52000	-52000
PVIF @ 16%	1.0000	0.8621	0.7432	0.6407	0.5523	0.4761	0.4104
PV	-1480000	-44828	-38644	-33314	-28719	-24758	-21343	-1671606
PVIFA (16%,6years)								3.6847
Equivalent cost(NPV/PVIFA (16%,6years))								-453657

16) a) A: $12380

Statement showing Equivalent annual cost of Machine A

Particulars	0	1	2	3	4	NPV
Cost of Machine	-892000
Operating cost		-28200	-28200	-28200	-28200
Cash flow	-892000	-28200	-28200	-28200	-28200
PVIF @ 15%	1.0000	0.8696	0.7561	0.6575	0.5718
PV	-892000	-24522	-21323	-18542	-16123	-972510
PVIFA(15%,4years)						2.8550
Equivalent cost(NPV/PVIFA(15%,4years))						-340637

Statement showing Equivalent annual cost of Machine B

Particulars	0	1	2	3	4	5	NPV
Cost of Machine	-1118000
Operating cost		-19500	-19500	-19500	-19500	-19500
Cash flow	-1118000	-19500	-19500	-19500	-19500	-19500
PVIF @ 15%	1.0000	0.8696	0.7561	0.6575	0.5718	0.4972
PV	-1118000	-16957	-14745	-12822	-11149	-9695	-1183367
PVIFA(15%,5years)							3.3522
Equivalent cost(NPV/PVIFA(15%,5years))							-353017

Thus Machine A should be selected as it will save $ 353017-340637 = $12380

17) b) $1433059

Statement showing NPV

Particulars	0	1	2	3	4	5	NPV
Initial cost	-2484000
Annual sales		2208000	2208000	2208000	2208000	2208000
Cost		-883200	-883200	-883200	-883200	-883200
Depreciation		-496800	-496800	-496800	-496800	-496800
PBT		828000	828000	828000	828000	828000
Tax @ 32%		264960	264960	264960	264960	264960
PAT		563040	563040	563040	563040	563040
Add: Depreciation		496800	496800	496800	496800	496800
Annual cash flow		1059840	1059840	1059840	1059840	1059840
Total cash flow	-2484000	1059840	1059840	1059840	1059840	1059840
PVIF @ 11%	1.0000	0.9009	0.8116	0.7312	0.6587	0.5935
PV	-2484000	954811	860190	774946	698149	628963	1433059

18) C) B,C,D,E,F

Research and development cost are sunk cost and hence are nor relevant

Similarly head office expenses are not relevant to project