Questions -
Q1. Square Manufacturing is considering investing in a robotics manufacturing line. Installation of the line will cost an estimated $10.0 million. This amount must be paid immediately even though construction will take three years to complete (years 0, 1, and 2). Year 3 will be spent testing the production line and, hence, it will not yield any positive cash flows. If the operation is very successful, the company can expect after-tax cash savings of $7.0 million per year in each of years 4 through 7. After reviewing the use of these systems with the management of other companies, Square's controller has concluded that the operation will most probably result in annual savings of $5.2 million per year for each of years 4 through 7. However, it is entirely possible that the savings could be as low as $2.8 million per year for each of years 4 through 7. The company uses a 14 percent discount rate.
Required: Compute the NPV under the three scenarios.
Q2. Rush Corporation plans to acquire production equipment for $612,500 that will be depreciated for tax purposes as follows: year 1, $122,500; year 2, $212,500; and in each of years 3 through 5, $92,500 per year. An 14 percent discount rate is appropriate for this asset, and the company's tax rate is 40 percent.
Required:
(a) Compute the present value of the tax shield resulting from depreciation.
(b) Compute the present value of the tax shield from depreciation assuming straight-line depreciation ($122,500 per year).
Q3. Star City is considering an investment in the community center that is expected to return the following cash flows:
|
Year
|
Net Cash Flow
|
|
1
|
$39,000
|
|
2
|
69,000
|
|
3
|
99,000
|
|
4
|
99,000
|
|
5
|
119,000
|
This schedule includes all cash inflows from the project, which will also require an immediate $219,000 cash outlay. The city is tax-exempt; therefore, taxes need not be considered.
Required:
(a) What is the net present value of the project if the appropriate discount rate is 24 percent?
(b) What is the net present value of the project if the appropriate discount rate is 14 percent?
Q4. The Johnson Research Organization, a nonprofit organization that does not pay taxes, is considering buying laboratory equipment with an estimated life of 7 years so it will not have to use outsiders' laboratories for certain types of work. The following are all of the cash flows affected by the decision:
|
Investment (outflow at time 0)
|
$7,000,000
|
|
Periodic operating cash flows:
|
|
|
Annual cash savings because outside laboratories
|
|
|
are not used
|
1,500,000
|
|
Additional cash outflow for people and supplies to operate
|
|
|
the equipment
|
300,000
|
|
Salvage value after seven years, which is the estimated
|
|
|
life of this project
|
500,000
|
|
Discount rate
|
6%
|
Required: Calculate the net present value of this decision. Should the organization buy the equipment?