Questions are from Chapter 2
Book to be used is FINANCIAL THEORY AND CORPORATE POLICY, FOURTH EDITION, Copeland Weston Shastri
1. Basic capital budgeting problem with straight line depreciation. The Roberts company has cash inflows of $140,000 per year on project A and cash outflows of $100,000 per year. The investment outlay on the project is $100,000. Its life is 10 years. The tax rate is 40%. The opportunity cost of capital is 12%.
a. Present two alternative formulations of the net cash flows adjusted for the depreciation tax shelter.
b. Calculate the net present value for project A, using straight line depreciation for tax purposes.
2. Basic replacement problem. The Virginia company is considering replacing a riveting machine with a new design that will increases earnings before depreciation from $20,000 per year to $51,000 per year. The new machine will cost $100,000 and has an estimated life of eight years, with no salvage value. The applicable corporate tax rate is 40% and the firms cost of capital is 12%. The old machine has been fully depreciated and has no salvage value. Should it be replaced with a new machine?
3. Calculate the internal rate of return for the following set of cash flows:
If the opportunity cost of capital is 10%, should the project be accepted?
4. The Ambergast Corporation is considering a project that has a three-year life and costs $1,200. It would save $360 per year in operating costs and increase revenue by $200 per year. It would be financed with a three-year loan with the following payment schedule (the annual rate of interest is 5%):
Payment Interest Repayment of Principal Balance
440.65 60.00 380.65 819.35
440.65 40.97 399.68 419.67
440.65 20.98 419.67 0
If the company has a 10% after tax weighted average cost of capital, has a 40% tax rate, and uses straight-line depreciation, what is the net present value of the project?