Question 1: Taxes (8 marks) A new manufacturing company is trying to determine i

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Question 1: Taxes (8 marks) A new manufacturing company is trying to determine if they should purchase a new piece of equipment to establish a new product line. The new machine will cost $250,000 with a service life of 8 years. The expected proceeds are provided in the cash flow diagram below. The company would like to perform an after-tax calculation to see if the new equipment is worth the investment. The company uses an after tax MARR of 10% and has a tax rate of 35%. The CCA depreciation rate for this type of equipment is 30%.

a) What is the salvage value at year 8?

b) Calculate the CTF and CSF.

c) What is the after tax present worth of the equipment for its 8-year life span?

Question 2: Replacement Decisions (18 marks) A local greenhouse is planning to buy a new solar-powered forklift this year to replace their old one that runs on propane. The purchase price of the new forklift would cost $30,000. Based on your previous experience with forklifts you estimate the operating and maintenance (O&M) costs shown in the table below. You can use a declining balance depreciation model to calculate salvage values with a depreciation rate of 40%. The company uses a MARR of 10% for all financial analysis. Strongly encourage you to use a spreadsheet to validate your answers for this question, but DO NOT submit a spreadsheet or a table of numbers as your answer … Show us all your calculations, for all years, to fully justify your answers.

a) What is the Economic Life of the Challenger? And what is its minimum Equivalent Annual Cost (EAC)? (16 marks)

b) If the Defender’s Economic Life is 2 years, with a minimum EAC = $14,000, when should they replace the old forklift? (1 mark)

c) If the Defender’s Economic Life is 2 years, with a minimum EAC = $12,000 and its EAC in year 3 = $14,100, when we should replace the old forklift? (1 mark)

Question 3: Inflation (10 marks) A computer engineering company is considering a 10-year contract to provide network services to the city of Kingston. The upfront set-up cost to the engineering company is $130,000. The contract pays year-end revenues in current/actual dollars of $40,000 for the first year, with increases of $5,000 each year thereafter; in other words $40,000 at the end of the first year, $45,000 at the end of the second, $50,000 at the end of the third year and so on. The company cannot estimate their periodic maintenance costs in current/actual dollars, but they know that based upon today’s dollars, the maintenance costs will be $12,000 every three years. Assume these costs occur at end of every third year of the contract. The company requires a real MARR of 8%. Assume that inflation will average 2.78% per year for at least the next 15 years.

a) Draw a well labeled cash flow diagram. Make sure that you identify each cash flow as real or actual.

b) Determine the PW of the project.

c) Based upon your analysis, should the company sign the contract? Justify your recommendation for full marks.

Question 4: Dealing with Uncertainty and Risk (12 marks) You are considering submitting a bid to supply and install a new computer system for the City of Kingston. You estimate that a proposal can be prepared at a cost of $5,000, but that such a bid will have only a 20% chance of being accepted. As an alternative, you can invest $20,000 on an extensive research study of the project before preparing the proposal. Such a proposal will have a 30% chance of being accepted.

If you get the job, you can either expand your personnel and staff or subcontract work to other companies. If you subcontract a major portion of the work, it is estimated that there is a probability of 70% that you will make a profit of $1.0 million and 30% probability of making a $2.0 million profit. If you complete the work in house, by increasing the number of your employees, there is a 60% chance the profit will be only $0.5 million and a 40% chance it will be $3.0 million.

Draw a fully labelled decision tree for this scenario. Based on maximizing the expected value, what should your strategy be?

Salvage = ? After Tax MARR = 10% G = $60,000 A $80,000 Years $250,000

Explanation / Answer

Q1.

a) What is the salvage value at year 8?

At the end of eaight years the machin is worth $ 14,412, This is the salvage value.

b) Calculate the CTF and CSF.

Capital Tax Factor CTF = 1 – [t*d (1 + i/2)]/ (i + d)*(1 + i)

=1-[.35*.30(1+.10/2)]/.10+.30*1+.10)

=.7494.

Capital Salvage Factor CSF = 1 – [t*d/ (i + d)]

=1-[.35*.30/.10+.30]

=.7375

Where t=tax rate, d=depreciation rate,i=MARR,

C.What is the after tax present worth of the equipment for its 8-year life span

Present worth of equpment calculated as under.

Discounting

Factor@10%

In above

1.CFAT= Cash flow after tax @35%

2.CFBT=Cash flow before tax.

3.in year 8 there is terminal cash flow of $ 14,412.00 which will be arise from sale of machine.

4.It is assume that cash flow from year 5 to 8 increse by $ 15000 per year.

Year Depreciation Net Book Value 0 0 2,50,000 1 250000*30%=75000 1,75,000 2 1,75,000*30%=52500 1,22,500 3 1,22,500*30%=36,750 85,750 4 85,750*30%=25,725 60,025 5 60025*30%=18008 42,017 6 42017*30%=12605 29,412 7 29,412*30%=8824 20,588 8 20588*30%=6176 14,412

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