PROBLEM 13-1

A. Purchase price of equipment

Additional investment in working capital
Initial investment outlay

9,000,000.00
3,000,000.00
###########

B. No, last years $50,000 expenditure is considered a sunk cost and does not represent an incremental cash flow. Hence, it should not be
included in the analysis.
C. The potential sale of the building represents an opportunity cost of conducting the project in that building. Therefore, the possible aftertax sale price must be charged against the project as a cost.
PROBLEM 13-2
A. Sales revenues
Operating costs
Depreciation
Operating income before taxes
Taxes (40%)
Operating income after taxes
Add back Depreciation
First year project cash flow

###########
###########
###########
1,000,000.00
(400,000.00)
600,000.00
2,000,000.00
2,600,000.00

B. The cannibalization of existing sales needs to be considered in this analysis on an after-tax basis, because the cannibalized sales represent
sales revenue the firm would realize without the new project but would lose if the new project is accepted. Thus, the after-tax effect
would be to reduce the projects cash flow by $1,000,000(1 T) = $1,000,000(0.6) = $600,000. Thus, the projects cash flow would now be
$2,000,000 rather than $2,600,000.
C. Sales revenues
Operating costs
Depreciation
Operating income before taxes
Taxes (30%)
Operating income after taxes
Add back Depreciation
First year project cash flow

###########
###########
###########
1,000,000.00
(300,000.00)
700,000.00
2,000,000.00
2,700,000.00

The projects cash flow would increase by $100,000.

PROBLEM 13-3
Original cost of equipment
Depreciation (80%)
Book value

###########
###########
4,000,000.00

Selling price
Book value
Gain on sale

5,000,000.00
###########
1,000,000.00

Selling price
Tax on gain (1,000,000 x 40%)
After-tax net salvage value

5,000,000.00
(400,000.00)
4,600,000.00

PROBLEM 13-4
Initial outlay
Present value of cash inflows
1 - (1.10-10)
9,000
0.10
Net present value
Chang should buy the new machine because the project has a positive net present value.

(40,000.00)
55,301.10
15,301.10

PROBLEM 13-5
SYSTEM A
Initial outlay
Present value of cash inflows
1 - (1.10-6)
6,000
0.10
Net present value of System A

(20,000.00)
26,131.56
6,131.56

System A's EAA

6,131.56 /

1 - (1.10-6)
0.10

1,407.85

SYSTEM B
Initial outlay
Present value of cash inflows
1 - (1.10-3)
6,000
0.10
Net present value of System B

(12,000.00)
14,921.11
2,921.11

System B's EAA

2,921.11 /

1 - (1.10-3)
0.10

1,174.62

System A should be chosen because it has a higher EAA than System B.

PROBLEM 13-6
A. Straight-line depreciation
Year 1 (800,000 / 4)
Year 2 (800,000 / 4)
Year 3 (800,000 / 4)
Year 4 (800,000 / 4)

200,000.00
200,000.00
200,000.00
200,000.00

MACRS accelerated depreciation

Year 1 (800,000 x 33%)
Year 2 (800,000 x 45%)
Year 3 (800,000 x 15%)
Year 4 (800,000 x 7%)

B.

Year
1
2
3
4
Year
1
2
3
4
Net present value

264,000.00
360,000.00
120,000.00
56,000.00

MACRS - SL
(264,000 - 200,000)
(360,000 - 200,000)
(120,000 - 200,000)
(56,000 - 200,000)
Cash flows
25,600.00
64,000.00
(32,000.00)
(57,600.00)

PV factor
0.909091
0.826446
0.751315
0.683013

Difference
64,000.00
160,000.00
(80,000.00)
(144,000.00)

Tax %
40%
40%
40%
40%

Cash flows
25,600.00
64,000.00
(32,000.00)
(57,600.00)

PV of cash flows
23,272.73
52,892.56
(24,042.07)
(39,341.58)
12,781.64

Ceteris paribus, the accelerated depreciation method will result in a higher NPV (by $12,781.64) than would the use of the straight-line
depreciation method.
PROBLEM 13-8

A. Base price
Modification
Increase in working capital
Net cost of spectometer

(140,000.00)
(30,000.00)
(8,000.00)
(178,000.00)

B.
After-tax savings
Depreciation tax savings
Salvage value
Tax on salvage value
Return of working capital
Project cash flows

Year 1
30,000.00
22,440.00

Year 2
30,000.00
30,600.00

52,440.00

60,600.00

Year 3
30,000.00
10,200.00
60,000.00
(19,240.00)
8,000.00
88,960.00

Computations:
Before-tax labor cost
Tax (40%)
After-tax savings

50,000.00
(20,000.00)
30,000.00

MACRS
Year 1 (170,000 x 33%)
Year 2 (170,000 x 45%)
Year 3 (170,000 x 15%)
Year 4 (170,000 x 7%)

Depreciation
56,100.00
76,500.00
25,500.00
11,900.00

Tax %
40%
40%
40%

Depreciation tax savings

22,440.00
30,600.00
10,200.00

Tax on salvage value [(60,000 - 11,900) x 40%]

C.

Year
0
1
2
3
Net present value

Cash flows
(178,000.00)
52,440.00
60,600.00
88,960.00

PV factor
1.000000
0.892857
0.797194
0.711780

19,240.00
PV of cash flows
(178,000.00)
46,821.43
48,309.95
63,319.97
(19,548.65)

The spectrometer should not be purchase because the net present value is negative.
PROBLEM 13-9
A. The $5,000 spent last year on exploring the feasibility of the project is a sunk cost and should not be included in the
analysis.
B.

Base price
Shipping and installation costs
Increase in working capital
Net cost of machine

(108,000.00)
(12,500.00)
(5,500.00)
(126,000.00)

C.
After-tax savings
Depreciation tax savings
Salvage value
Tax on salvage value
Return of working capital
Project cash flows

Year 1
28,600.00
13,917.75

Year 2
28,600.00
18,978.75

42,517.75

47,578.75

Year 3
28,600.00
6,326.25
65,000.00
(19,797.75)
5,500.00
85,628.50

Computations:
Before-tax labor cost
Tax (35%)
After-tax savings
MACRS
Year 1 (120,500 x 33%)
Year 2 (120,500 x 45%)
Year 3 (120,500 x 15%)

44,000.00
(15,400.00)
28,600.00
Depreciation
39,765.00
54,225.00
18,075.00

Tax %
35%
35%
35%

Depreciation tax savings

13,917.75
18,978.75
6,326.25

Year 4 (120,500 x 7%)

8,435.00

Tax on salvage value [(65,000 - 8,435) x 35%]

D.

Year
0
1
2
3
Net present value

Cash flows
(126,000.00)
42,517.75
47,578.75
85,628.50

PV factor
1.000000
0.892857
0.797194
0.711780

19,797.75
PV of cash flows
(126,000.00)
37,962.28
37,929.49
60,948.67
10,840.44

The machine should be purchase because the net present value is positive.
PROBLEM 13-10
Purchase price
Sale of old machine
Tax on sale of old machine
Change in net working capital (2,000 - 500)
Total investment

160

Selling price
Book value
Gain on sale

2,500.00
(2,100.00)
400.00

Tax on gain (2,100 x 40%)

160.00

Year 0
After-tax revenue
increase
Depreciation tax
savings
Salvage value
Tax on SV (800 x 40%)
Return of working
capital

Year 1

Year 2

Year 3

Year 4

Year 5

1,500.00

3,000.00

4,500.00

6,000.00

7,500.00

9,000.00

500.00

884.00

468.00

244.00

212.00

52.00
800.00
(320.00)
1,500.00

After-tax oppor-tunity
cost
Project cash flows

2,000.00

3,884.00

4,968.00

6,244.00

7,712.00

Computations:
Increase in sales
Decrease in cost
Pre-tax revenue increase
Tax (40%)
After-tax revenue increase
MACRS
Year 1 (8,000 x 20%)
Year 2 (8,000 x 32%)
Year 3 (8,000 x 19%)
Year 4 (8,000 x 12%)
Year 5 (8,000 x 11%)
Year 6 (8,000 x 6%)
Depreciation:
New
Old
Change

(8,000.00)
2,500.00
(160.00)
(1,500.00)
(7,160.00)

-300
10,732.00

1,000.00
1,500.00
2,500.00
(1,000.00)
1,500.00
7200
1,600.00
2,560.00
1,520.00
960.00
880.00
480.00

Year 1
1,600.00
350.00
1,250.00

Year 2
2,560.00
350.00
2,210.00

Year 3
1,520.00
350.00
1,170.00

Year 4
960.00
350.00
610.00

Year 5
880.00
350.00
530.00

Year 6
480.00
350.00
130.00

Tax (40%)
Depreciation taxsavings

500.00

884.00

468.00

244.00

212.00

52.00

750.00

1,326.00

702.00

366.00

318.00

78.00

Pre-tax opportunity cost of old machine

Tax (40%)
After-tax opportunity cost of old machine
Year
0
1
2
3
4
5

Cash flows
(7,160.00)
2,000.00
3,884.00
4,968.00
6,244.00
7,712.00
10,732.00

Net present value

500.00
(200.00)
300.00

PV factor
1.000000
0.869565
0.756144
0.657516
0.571753
0.497177
0.432328

PV of cash flows
(7,160.00)
1,739.13
2,936.86
3,266.54
3,570.03
3,834.23
4,639.74
12,826.53

12826.53

The machine replacement should be made because the net present value is positive.
PROBLEM 13-12
A. Project A
Probable cash flow
Probability
Cash flow
1,200.00
0.20 x
6000
4,050.00
0.60 x
6750
1,500.00
0.20 x
7500
6,750.00
Expected annual cash flow
Project B
Probability
Cash flow
0.20 x
0
0.60 x
6750
0.20 x
18000
Expected annual cash flow

Probable cash flow

4,050.00
3,600.00
7,650.00

A = SQRT[(6,000 - 6,750)2 x 0.20] + [(6,750 - 6,750)2 x 0.60] + [(7,500 - 6,750)2 x 0.20]

A = SQRT[(-7502 x 0.20) + (02 x 0.60) + (7502 x 0.20)]
A = 474.34
B = SQRT[(0 - 7,650)2 x 0.20] + [(6,750 - 7,650)2 x 0.60] + [(18,000 - 7,650)2 x 0.20]
B = SQRT[(02 x 0.20) + (-9002 x 0.60) + (10,3502 x 0.20)]
B = 5797.84
CVA = 474.34 / 6,750
CVA = 0.070273
CVB = 5,797.84 / 7,650
CVB = 0.757888
B. Project B is the riskier project because it has the greater variability in its probable cash flows, whether measured by the
standard deviation or the coefficient of variation. Hence, Project B is evaluated at the 12% cost of capital, while Project A
requires only a 10% cost of capital.
Project A
Initial outlay
Present value of cash inflows
1 - (1.10-3)
6,750
0.10
Net present value of System B

(6,750.00)
16,786.25
10,036.25

Project B
Initial outlay
Present value of cash inflows
1 - (1.12-3)
7,650
0.12
Net present value of System B

(6,750.00)
18,374.01
11,624.01

Project B has the higher NPV; therefore, the firm should accept Project B.
C. The portfolio effects from Project B would tend to make it less risky than otherwise. This would tend to reinforce the decision to accept
Project B. Again, if Project B were negatively correlated with the GDP (Project B is profitable when the economy is down), then it is less
risky and Project B's acceptance is reinforced.
PROBLEM 13-13
A. Project A
Year
0
1
2
Net present value

Cash flows
(10,000.00)
6,000.00
8,000.00

PV factor
1.000000
0.909091
0.826446

PV of cash flows
(10,000.00)
5,454.55
6,611.57
2,066.12

Project B
Initial outlay
Present value of cash inflows
1 - (1.10-4)
4,000
0.10
Net present value

(10,000.00)
12,679.46
2,679.46

Since neither project can be repeated, Project B should be selected because it has a higher NPV than Project A.
B.

Project A's Extended NPV

Year 0
Year 1
(10,000.00)
6000
(10,000.00)
Project A
Year
0
1
2
3
4
Net present value

6,000.00

Cash flows
(10,000.00)
6,000.00
(2,000.00)
6,000.00
8,000.00

Project B
Initial outlay
Present value of cash inflows
1 - (1.10-4)
4,000
0.10
Net present value

Year 2
8000
(10,000.00)
(2,000.00)

PV factor
1.000000
0.909091
0.826446
0.751315
0.683013

Year 3
6000
6,000.00

Year 4
8000
8,000.00

PV of cash flows
(10,000.00)
5,454.55
(1,652.89)
4,507.89
5,464.11
3,773.65

(10,000.00)
12,679.46
2,679.46

Since Project As extended NPV = $3,773.65, it should be selected over Project B with an NPV = $2,679.46.
C.

Project A's EAA

3,733.65 /

1 - (1.10-4)
0.10

1,190.48

Project B's EAA

2,679.46 /

1 - (1.10-4)
0.10

845.29

Since Project As EAA = $1,190.48, it should be selected over Project B with an EAA = $845.29.
PROBLEM 13-14
Machine 190-3
Initial outlay
Present value of cash inflows
1 - (1.14-3)
87,000
0.14
Net present value
Machine 190-3's Extended NPV
Year 0
Year 1
(190,000.00)
87,000.00
(190,000.00)

87,000.00

Year
Cash flows
0
(190,000.00)
1
87,000.00
2
87,000.00
3
(103,000.00)
4
87,000.00
5
87,000.00
6
87,000.00
Extended net present value

(190,000.00)
201,981.99
11,981.99

Year 2
87,000.00
87,000.00
PV factor
1.000000
0.877193
0.769468
0.674972
0.592080
0.519369
0.455587

Year 3
87,000.00
(190,000.00)
(103,000.00)

Year 4
87,000.00
87,000.00

Year 5
87,000.00
87,000.00

Year 6
87,000.00
87,000.00

PV of cash flows
(190,000.00)
76,315.79
66,943.67
(69,522.07)
51,510.98
45,185.07
39,636.03
20,069.49

Machine 190-3's EAA

11,981.99 /

1 - (1.14-6)
0.14

5,161.02

Machine 360-6
Initial outlay
Present value of cash inflows
1 - (1.14-6)
98,300
0.14
Net present value

(360,000.00)
382,256.02
22,256.02

Machine 360-6's EAA

22,256.02 /

1 - (1.14-6)
0.14

5,723.30

Both new machines have positive NPVs; hence the old machine should be replaced. Further, since its NPV is greater with the
replacement chain approach and its EAA is higher than Model 190-3, choose Model 360-6.

PROBLEM 13-17
Project X's NPV
Year
0
1
2
3

Cash flow
(100,000.00)
30,000.00
50,000.00
70,000.00

PV factor
1.000000
0.892857
0.797194
0.711780

PV of CF
(100,000.00)
26,785.71
39,859.69
49,824.62

NPV

16,470.03

Project X's EAA

1 - (1.12-3)
0.12

16,470.03 /
Project Y's NPV
Year
0
1
2
3
4
5
NPV

Cash flow
(70,000.00)
30,000.00
30,000.00
30,000.00
30,000.00
10,000.00

6,857

PV factor
1.000000
0.892857
0.797194
0.711780
0.635518
0.567427

PV of CF
(70,000.00)
26,785.71
23,915.82
21,353.41
19,065.54
5,674.27
26,794.75

Project X's EAA

1 - (1.12-5)
0.12

26,794.75 /

7,433

PROBLEM 13-19

Cost of the new machine

Increase in working capital
Pre-tax cost savings
Depreciation
Operating income before tax
Tax (40%)
Operating income after tax
Depreciation
Operating cash flow
Return of net working capital
Sale of machine
Tax on sale (40%)
Operating cash flows
MACRS depreciation
1
250,000.00
2
250,000.00
3
250,000.00
4
250,000.00
5
250,000.00

X
X
X
X

Year
0
1
2
3
4
5
NPV

1
2
3
4
5

33%
45%
15%
7%

Year 0
(250,000.00)
(20,000.00)

(270,000.00)

Year 1

Year 2

Year 3

Year 4

108,000.00
(82,500.00)
25,500.00
(10,200.00)
15,300.00
82,500.00
97,800.00

108,000.00
(112,500.00)
(4,500.00)
1,800.00
(2,700.00)
112,500.00
109,800.00

108,000.00
(37,500.00)
70,500.00
(28,200.00)
42,300.00
37,500.00
79,800.00

108,000.00
(17,500.00)
90,500.00
(36,200.00)
54,300.00
17,500.00
71,800.00

97,800.00

109,800.00

79,800.00

71,800.00

0.10
0.15
0.20

312,035.13
276,893.97
247,892.23

82,500.00
112,500.00
37,500.00
17,500.00

Cash flow
(270,000.00)
97,800.00
109,800.00
79,800.00
71,800.00
101,600.00

PV factor
1.000000
0.909091
0.826446
0.751315
0.683013
0.620921

97,800.00
109,800.00
79,800.00
71,800.00
101,600.00

0.16
0.862068966
0.743162901
0.640657674
0.552291098
0.476113015

PV of CF
(270,000.00)
88,909.09
90,743.80
59,954.92
49,040.37
63,085.61
81,733.79

84,310.34
81,599.29
51,124.48
39,654.50
48,373.08

1.464100
1.331000
1.210000
1.100000
1.000000

143,188.98 MIRR
146,143.80
96,558.00
78,980.00
101,600.00

305,061.70

Year
1.00
2.00
3.00
4.00
5.00

566,470.78

Cash flow
Balance
(270,000.00) (270,000.00)
97,800.00
(172,200.00)
109,800.00
(62,400.00)
79,800.00
17,400.00
71,800.00
89,200.00
101,600.00
190,800.00

0.35
0.35
0.3

-7663.52
37035.13
81733.79

(2,682.23)
12,962.30
24,520.14
34,800.20

(42,463.72)
2,234.93
46,933.59

631,108,645.55
1,748,218.45
660,828,547.01
1,293,685,411.01
35,967.84
1.033553

ence, it should not be

re, the possible after-

alized sales represent

s, the after-tax effect
sh flow would now be

se of the straight-line

er measured by the
ital, while Project A

2500
1000

5000
2000

7500
3000

10000
4000

12500
5000

15000
6000

he decision to accept
down), then it is less

V is greater with the

Year 5

108,000.00
108,000.00
(43,200.00)
64,800.00
64,800.00
20,000.00
28,000.00
(11,200.00)
101,600.00

15.97%

PROBLEM 13-10
Purchase price
Sale of old machine
Tax on sale of old machine
Change in net working capital (2,000 - 500)
Total investment

160

Selling price
Book value
Gain on sale

2,500.00
(2,100.00)
400.00

Tax on gain (2,100 x 40%)

After-tax revenue increase

Depreciation tax savings

160.00
Year 1
1,500.00
500.00
2,000.00

Year 2
3,000.00
884.00
3,884.00

Year 3
4,500.00
468.00
4,968.00

Year 4
6,000.00
244.00
6,244.00

Year 5
7,500.00
212.00
7,712.00
800.00
(128.00)
1,500.00

2,000.00

3,884.00

4,968.00

6,244.00

9,884.00

Salvage value
Tax on SV (800 x 40%)
Return of working capital
After-tax oppor-tunity cost
Project cash flows
MACRS
Year 1 (8,000 x 20%)
Year 2 (8,000 x 32%)
Year 3 (8,000 x 19%)
Year 4 (8,000 x 12%)
Year 5 (8,000 x 11%)
Year 6 (8,000 x 6%)
Depreciation:
New
Old
Change
Tax (40%)

7200
1,600.00
2,560.00
1,520.00
960.00
880.00
480.00
Year 1
1,600.00
350.00
1,250.00
500.00

Year 2
2,560.00
350.00
2,210.00
884.00

Year 3
1,520.00
350.00
1,170.00
468.00

Year 4
960.00
350.00
610.00
244.00

Pre-tax opportunity cost of old machine

Tax (40%)
After-tax opportunity cost of old machine
Year
0
1
2
3

(8,000.00)
2,500.00
(160.00)
(1,500.00)
(7,160.00)

Cash flows
PV factor
(7,160.00) 1.000000
2,000.00
0.869565
3,884.00
0.756144
4,968.00
0.657516

Year 5
880.00
350.00
530.00
212.00

Year 6
480.00
350.00
130.00
52.00
500.00
(200.00)
300.00

PV of cash flows
(7,160.00)
1,739.13
2,936.86
3,266.54

4
5
Net present value

6,244.00
9,884.00

0.571753
0.497177

3,570.03
4,914.09
9,266.66

PROBLEM 13-19
Year 0
(250,000.00)
(20,000.00)

Cost of the new machine

Increase in working capital
Pre-tax cost savings
Depreciation
Operating income before tax
Tax (40%)
Operating income after tax
Depreciation
Operating cash flow
Return of net working capital
Sale of machine
Tax on sale (40% x 17,500)
Operating cash flows

(270,000.00)

Year 1

Year 2

108,000.00
(82,500.00)
25,500.00
(10,200.00)
15,300.00
82,500.00
97,800.00

108,000.00
(112,500.00)
(4,500.00)
1,800.00
(2,700.00)
112,500.00
109,800.00

97,800.00

109,800.00

MACRS depreciation
1
2
3
4
5

250,000.00
250,000.00
250,000.00
250,000.00
250,000.00

X
X
X
X

33%
45%
15%
7%

Year
0
1
2
3
NPV

Cash flow
(270,000.00)
97,800.00
109,800.00
120,800.00

1
2
3

1.00
2.00
3.00
Year
1.00
2.00
3.00

82,500.00
112,500.00
37,500.00
17,500.00

PV factor
1.000000
0.909091
0.826446
0.751315

97,800.00
109,800.00
120,800.00

0.16
1
1
1

97800
109800
120800

0.1
0.91
0.27
0.48

Cash flow
Balance
(270,000.00) (270,000.00)
97,800.00
(172,200.00)
109,800.00
(62,400.00)
120,800.00
58,400.00

PV of CF
(270,000.00)
88,909.09
90,743.80
90,758.83
411.72

97,800.00
109,800.00
120,800.00
328,400.00
88,909.09
30,126.53
58,367.86
177,403.48

0.10
0.15
0.20

1.464100
1.331000
1.210000

#REF!
#REF!

#REF!
#REF!

#REF!
#REF!

#REF!
#REF!

0.35
0.35
0.3

-7663.52
37035.13
81733.79

(2,682.23)
12,962.30
24,520.14
34,800.20

(7,663.52)
37,035.13
81,733.79

Year 3

108,000.00
(37,500.00)
70,500.00
(28,200.00)
42,300.00
37,500.00
79,800.00
20,000.00
28,000.00
(7,000.00)
120,800.00

312,035.13
276,893.97
247,892.23

143,188.98 MIRR
146,143.80
146,168.00
435,500.78

17.28%

20,555,338.58
480,060,298.94
2,004,123,728.33
2,504,739,365.85
50,047.37
1.438135