All quantitative work must be done in Excel; Word is not acceptable.
1. Although the Chen Company's milling machine is old, it is still in relatively good working order and would last for another 10 years. It is inefficient compared to modern standards though, and so the company is considering replacing it. The new milling machine, at a cost of $110,000 delivered and installed, would also last for 10 years and would produce after-tax cash flows ( labor saving and depreciation tax savings) of $19,000 per year. It would have zero salvage at the end of its life. The project cost of capital is 10%, and its marginal tax rate is 35%. Should Chen buy the new machine?
2. Wendy's boss wants to use straight-line depreciation for the new expansion project because he said it will give higher net income in earlier years and give him a larger bonus. The project will last 4 years and requires $1,7000,00 of equipment. The company could either use straight line or 3-year MACRS accelerated method. Under straight-line depreciation, the cost of the equipment would depreciate evenly over its 4-year life. (Ignore the half-year convention for the straight-line method.) The applicable MARCS depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41% as discussed in Appendix 11A. The project cost of capital is 10%, and its tax rate is 40%.
a. What would the depreciation expense be each year under each method?
b. Which depreciation method would produce the higher NPV, and how much higher would it be?
c. Why might Wendy's boss prefer straight-line depreciation?
3. The president of the company you work for has asked you to evaluate the proposed acquisition of a new chromatograph for the firm's R&D department. The equipment's basic price is $70,000, and it would cost another $15,000 to modify it for special use by your firm. The chromatograph, which falls into the MARCS 3-year class, would be sold after 3 years for $30,000. The MARCS rates for the first 3 years are 0.3333, 0.4445, and 0.1481. Use of the equipment would require an increase in net working capital (spare parts inventory) of $4,000. The machine would have no effect on revenues, but it is expected to save the firm $25,000 per year in before-tax operating costs, mainly labor. The firm's marginal federal-plus-state tax rate is 40%.
a. What is the Year-0 net cash flow?
b. What are the net operation cash flows in Years 1, 2, and 3?
c. What is the additional (nonoperating) cash flow is Year 3?
d. If the project's cost of capital is 10%, should the chromatograph be purchased?