Project Evaluation

Assignment
Instructor: Dr. Syed Kashif Saeed

Due Date:

Problem 1:
A Plastic manufacturer has under consideration the proposal of production of high quality
plastic glasees. The necessary equipment to manufacture the glasses would cost Rs 180,000. The
production equipment would last five years with salvage value of Rs 20,000. It is also estimated that an
additional investment in working capital would be required at start of project amounted to Rs 150,000.
The glasses can be sold at Rs 3/- each. Regardless of level of production, the manufacturer will incur
cash cost of Rs 87,000 each year. The variable cost is estimated at Rs 2.0 per glass. The manufacturer
estimates it will sell about 75000 glasses in first year and there will be increase of 10% per year for next
four years. Fixed cost is also expected to increase 15% per year but no change in variable cost is
expected. The straight line method for depreciation will be used; the ordinary tax rate is 55%. Should
the proposed equipment be purchased? Assume cost of capital is 12%.

Problem 2:

A firm is trying to determine whether to replace an existing asset. The proposed asset has a purchase
price of $50,000 and has installation costs of $3,000. The asset will be depreciated over its five year life
using the straight-line method. The new asset is expected to increase sales by $17,000 and non-
depreciation expenses by $2,000 annually over the life of the asset. Due to the increase in sales, the firm
expects an increase in working capital during the asset’s life of $1,500, and the firm expects to be able to
sell the asset for $6,000 at the end of its life. The existing asset was originally purchased three years ago
for $25,000, has a remaining life of five years, and is being depreciated using the straight-line method.
The expected salvage value at the end of the asset’s life (i.e., five years from now) is $5,000; however,
the current sale price of the existing asset is $20,000, and its current book value is $15,625. The firm’s
marginal tax rate is 34 percent and its required rate of return is 12 percent. Whether we go on or reject
the proposal.
Problem 3: (Very Interesting Problem)
Problem 4:
A Machine purchased six years ago for Rs 150,000 has been depreciated to a book value of Rs
90,000. It originally has projected life of 15 years and Zero salvage value. A new machine will cost Rs
250,000 and result in reduce operating cost of Rs 30,000 per year for the nest nine years. The older
machine could be sold for Rs 50,000. The cost of capital is 10%. The new machine will be depreciated on
a straight line basis over nine year life with Rs 25,000 salvage value. The company tax rate is 55%. Should
we replace the old machine?

Problem 5:
The Michener Company purchased a special machine 1 year ago at a cost of $12,000. At that
time, the machine was estimated to have a useful life of 6 years and no disposal value. The annual cash
operating cost is approximately $20,000. A new machine that has just come on the market will do the
same job but with an annual cash operating cost of only $17,000. This new machine costs $15,000 and
has an estimated life of 5 years with no disposal value. The old machine could be used as a trade-in at an
allowance of $5,000. Straight-line depreciation is used and the company’s income tax rate is 40 percent.
Compute the internal rate of return on the new investment.

Problem 6: (Interesting Problem)

The Baxter Company manufactures toys and short-lived fad-type items. The research and
development department came up with item that would make a good promotion gift for office
equipment dealers. Aggressive and effective effort by Baxter’s sales personnel has resulted in almost
firm commitments for this product for the next 3 years. It is expected that the product’s value will be
exhausted by that time. In order to produce the quality demanded Baxter will need to buy additional
machinery and rent some additional space. It appears that about 25,000 square feet will be needed:
12,500 square feet of presently unused, but leased, space is available now. (Baxter’s present lease with
10 years to run costs $3.00 a square foot.) There is another 12,500 square feet adjoining the Baxter
facility which Baxter will rent for 3 years at $4.00 per square foot per year if it decides to make this
product.
The equipment will be purchased for about $900,000.It will require $30,000 in modifications,
$60,000 for installation, and $90,000 for testing: All of these activities will be done by a firm of engineers
hired by Baxter. All of the expenditures will be paid for on January 1, 19x1. The equipment should have a
salvage value of about $180,000 at the end of the third year. No additional general overhead costs are
expected to be incurred. The following estimates of revenues and expenses for this product for the 3
years have been developed.
 19X1 19X2 19X3
Sales 1,000,000 1,600,000 800,000
Material, Labor and FOH 400,000 750,000 350,000
Assigned General FOH 40,000 75,000 35,000
Rent 87,500 87,500 87,500
Depreciation 450,000 300,000 150,000
977,500 1,212,500 622,500
Income Before tax 22,500 387,500 177,500
Income Tax @40% 9,000 155,000 71,000
Income after tax 13,500 232,500 106,500

1. Prepare a schedule which shows the incremental after tax cash flows for this project.
2. If the company requires a 2-Year payback period for its investment, would it undertake this
project? Show your supporting calculations clearly.
3. A newly hired business graduate recommends that the company consider the use of net
present value analysis to study this project. If the company sets a required rate of return of 20
percent after taxes, will this project be accepted? Assume all revenue and expenses occur at
the end of year.

Problem 7: (Some parts of this problem are difficult, just try to attempt it)

Fill in the blanks of the following independent cases. Assume in the investment of 5 years.

Annual Cash
Investment Cost of capital IRR NPV
Inflow

a) 100,000 449,400 14% ? ?

b) 70,000 ? 14% 20% ?
c) ? 200,000 ? 14% 35,624
d) ? 300,000 12% ? 39,000

Problem 8:

A chemical company is considering replacing an existing machine with one costing Rs 65,000.
The existing machine was originally purchased two years ago for Rs 28,000 and is being depreciated by
straight line method over seven years. It can currently be sold for Rs 30,000 with no removal cost. The
new machine would cost Rs 10,000 to install and would be depreciated over five years. The
management believes that new machine would have salvage value of Rs 5000 after five years. An
increase of Rs 10,000 in working capital is also expected due to new machine. Tax rate is 55% on
ordinary income and 30% on capital gain. The company expected after tax profits for next five years with
existing machine and new machine are given below:
 Saving before Depr & tax
Year Existing machine New Machine

1 200,000 246,000
2 150,000 190,000
3 180,000 230,000
4 210,000 240,000
5 220,000 270,000

Compute the net investment required by the new machine. Also should company purchase new
machine if cost of capital is 20%.