2. A piece of newly purchased industrial equipment costs $8,200,000, has a salva

Question

2. A piece of newly purchased industrial equipment costs $8,200,000, has a salvage value of $350,000 and is classified as a seven-year property under MACRS. Calculate the annual depreciation allowances and the end-of-year book values for this equipment. If the equipment is sold for 30% of the initial cost in year 5, what is the after-tax cash flow from the sale if the tax rate is 35%?

3.) Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next five years, because the rm needs to plow back its earnings to fuel growth. The company will then pay a dividend of $15 per share 7 years from today and will increase the dividend by 4 percent per year thereafter. If the required return on this stock is 13 percent, what is the current share price?

4.You are also considering another project which has a physical life of 3 years; that is, the machinery will be totally worn out after 3 years. However, if the project were terminated prior to the end of 3 years, the machinery would have a positive salvage value. Here are the project’s estimated cash flows:

Initial Investment End-of-Year

And Operating Net Salvage

Year Cash Flows Value

0 ($8,000) $8,000

1 3,900 5,100

2 3,000 2,500

3 2,550 0

5. Using the 8% cost of capital, what is the project’s NPV if it is operated for the full 3 years? Would the NPV change if the company planned to terminate the project at the end of Year 2? At the end of Year 1? What is the project’s optimal (economic) life?

Explanation / Answer

3)

Asset cost $        8,200,000 Less: Depreciatioon charged $        6,370,580 8200000*(0.1429+0.2449+0.1749+0.1249+0.0893) WDV of machine at the time of sale $        1,829,420 Sale value of machine $        2,460,000 8200000*0.3 Profit on sale $            630,580 Less: Tax on sale @ 30% $            220,703 After tax cash flows from sale of asset $        2,239,297

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