Question

Q1. A company plans to undertake an expansion project and is evaluating two proposals, A and B.

Proposal A Proposal B

Year 0 -$150,000 -$150,000

Year 1   $50,000 $60,000

Year 2 $50,000                           $55,000
Year 3 $50,000                           $50,000
Year 4   $50,000                           $40,000
Year 5   $50,000                           $35,000

Since the previous answer gave results, what is the cross-over rate?

A. 16.94%

B. 17.20%

C. 16.66%

D. 16.20%

Q2. ABC Inc. is considering purchase of a new equipment that will produce a new range of spare parts to complement its existing line of products. The new equipment will cost $500,000. Sales are expected to be around $200,000 per year and variable costs at $60,000. At the end of five years, the equipment can be sold for $100,000. Using straight line depreciation, should they purchase this equipment. Assume the cost of capital is 12% and the tax rate is 30%. Why or why not?

A. No, NPV = - $38,588.65

B. Yes, NPV = #24,000.44

C. No, NPV = - $12,086.99

D. Yes, NPV = $1,131.23

Q3. Red Hook Inc. is considering the purchase new equipment to improve their production rates. They are considering two competing offers. Offer A's equipment costs $400,000 and will help increase after-tax cash flows by $120,000 for six years. Offer B's equipment costs $700,00 and will help increase after-tax cash flows by 152,000 for 10 years. Which offer should they accept and why? Note the offers have unequal lives and assume a discount rate of 15%.

		A. Choose B because EANPV= $12,523.56
		B. Choose A because EANPV = $14,305.24
		C. Choose A because EANPV = $54,127.92
		D. Choose B because EANPV = $62,852.83

Answer 1

Q1

Cross over rate	16.94%	Project A	Project B
Year	Discount factor	Cash flow	Present value @ 0.1694	Cash flow	Present value @ 0.1694
0	1	$    (150,000)	$ (150,000.00)	$    (150,000)	$ (150,000.00)
1	0.855139	$        50,000	$     42,756.97	$        60,000	$     51,308.36
2	0.731263	$        50,000	$     36,563.17	$        55,000	$     40,219.49
3	0.625332	$        50,000	$     31,266.61	$        50,000	$     31,266.61
4	0.534746	$        50,000	$     26,737.31	$        40,000	$     21,389.84
5	0.457282	$        50,000	$     22,864.12	$        35,000	$     16,004.89
	NPV		$    10,188.17		$     10,189.19

Answer is 16.94% at this rate NPV is equal under both.

2

Year	Cash flow	× factor@ 12.0%	Present value
0	$    (500,000.00)	1.0000	$          (500,000.00)
1	$     128,000.00	0.8929	$           114,285.71
2	$     128,000.00	0.7972	$           102,040.82
3	$     128,000.00	0.7118	$             91,107.87
4	$     128,000.00	0.6355	$             81,346.31
5	$     128,000.00	0.5674	$             72,630.64
5	$        70,000.00	0.5674	$             39,719.88
			$                            -
NPV		4.1722	$                1,131.23

Particulars	Amount
Sales	200000
Less: costs	-60000
Depreciation	-100000
PBT	40000
Less: taxes	-12,000.00
net income	28000
Add: depreciation	100000
Cash flow	128000

Terminal flow = 100000*(1-30%) =70000

Yes, NPV is 1,131.23

Q3

Project A	Year	Cash flow	× discount factor	Present value
		$    (400,000)		$(400,000.00)
	1	$     120,000	0.869565	$ 104,347.83
	2	$     120,000	0.756144	$    90,737.24
	3	$     120,000	0.657516	$    78,901.95
	4	$     120,000	0.571753	$    68,610.39
	5	$     120,000	0.497177	$    59,661.21
	6	$     120,000	0.432328	$    51,879.31
	Total		3.784483	$    54,137.92
(a)	EAA - A	54137.92/ 3.784483	$    14,305.24
Project B	Year	Cash flow	× discount factor	Present value
		$    (700,000)		$(700,000.00)
	1	$     152,000	0.869565	$ 132,173.91
	2	$     152,000	0.756144	$ 114,933.84
	3	$     152,000	0.657516	$    99,942.47
	4	$     152,000	0.571753	$    86,906.49
	5	$     152,000	0.497177	$    75,570.86
	6	$     152,000	0.432328	$    65,713.79
	7	$     152,000	0.375937	$    57,142.43
	8	$     152,000	0.326902	$    49,689.07
	9	$     152,000	0.284262	$    43,207.89
	10	$     152,000	0.247185	$    37,572.08
	Total		5.018769	$    62,852.83
(b)	EAA - B	62852.83/ 5.018769	$    12,523.56

Answer is:

B. Choose A because EANPV = $14,305.24

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