Transcript Chap 10 - Problem Set

Chapter 10
Capital Budgeting
1. Pearl’s Parkade Ltd is analyzing the
replacement of its existing ticketing procedure
to reduce parkade labour costs. The new
machine would cost $100,000. It would cause
labour costs to fall by $30,000 per year for its
fifteen year expected useful life. Salvage
value is estimated at $5,000. CCA is charged
at 10%. The firm’s cost of capital is 12% and
its corporate tax rate is 40%. Should Pearl buy
the machine or continue using manual labour?
• Answer: -$20,749 - Reject
2.
Alki Dyes has just obtained a new filtration tank at a
cost of $18,000. The estimated liquidation value of the
new tank, at the end of its three year useful life, is
$1,000. The CCA rate is 50%. Estimated pre-tax cash
flows before depreciation and taxes are estimated as
follows:
Year 1
$10,000
Year 2
$10,000
Year 3
$10,000
It is estimated that NWC will rise by $4,000 at the start
of the project but this will be recovered when the
project ends in three years. The corporate tax rate is
40% and the cost of capital is 14%. What is the
project’s NPV?
Answer: +$373
3.
Randy-White Trucking is analyzing a replacement issue for its
current fleet of trucks. Two options are under consideration:
Option A:
Purchase new Kenworths at a cost of $250,000 per new tractor.
The tractors have a useful life of 10 years and an estimated
salvage value of $50,000 at that time. The dealer will offer
$15,000 as a trade-in value on the firm’s existing trucks
Option B:
Purchase new Western Star trucks at a cost of $150,000 per new
tractor. These trucks are expected to last for 6 years, at which
time they could be sold for $30,000. At the end of year 6, a new
Western Star truck will be purchase at a cost of $150,000. It will
have a salvage value of $50,000 at the end of year 4. No trade-in
value will be given for the firm’s existing trucks.
The firm’s tax rate is 25% and their cost of capital is 18%. Trucks
are a class 10 asset with a 30% CCA rate. Which option should
the firm choose & why.
Answer: Option A - $193,021
Option B - $158,458
4.
RM Glassworks has annual cash revenues of
$400,000, annual cash expenses of 200,000 and
annual depreciation expense of $60,000. These are
expected to remain constant, as long as RM continues
to have an outside firm do its packaging. However, if a
new packaging machine is purchased at a cost of
$100,000, RM will be able to reduce delivery time,
thereby increasing sales to time sensitive customers.
The packaging machine has a life of 20 years, an
expected salvage value of $10,000 and a CCA rate of
10%. The new machine is expected to increase the
firm’s annual cash revenues to $500,000 with annual
cash expenses of $260,000. Due to the increase in
sales, NWC is expected to rise by $50,000 initially but
this will be recovered at the end of the 20 year period.
Given a corporate tax rate of 40% and a 12% cost of
capital, should RM purchase the new machine?
Answer: $52,504