2-9 INTRODUCTORY PROJECT VALUATION The CT Computers Corporation is

considering whether to begin offering customers the option to have their old personal computers
(PCs) recycled when they purchase new systems. The recycling system would require CT
Computers to invest $600,000 in the grinders and magnets used in the recycling process. The
company estimates that for each system it recycles, it would generate $1.50 in incremental
revenues from the sale of scrap metal and plastics. The machinery has a five-year useful life and
will be depreciated using straight-line depreciation toward a zero salvage value. CT Computers
estimates that in the first year of the recycling investment, it could recycle 100,000 PCs and that
this number will grow by 25% per year over the remaining four-year life of the recycling
equipment. CT Computers uses a 15% discount rate to analyze capital expenditures and pays
taxes equal to 30%.
a. What are the project cash flows? You can assume that the recycled PCs cost CT Computers
nothing.
b. Calculate the NPV and IRR for the recycling investment opportunity. Is the investment a good
one based on these cash flow estimates?
c. Is the investment still a good one if only 75,000 units are recycled in the first year?
d. Redo your analysis for a scenario in which CT Computers incurs a cost of $0.20 per unit to
dispose of the toxic elements from the recycled computers. What is your recommendation under
these circumstances?
2-10 PROJECT VALUATION Glentech Manufacturing is considering the purchase of an
automated parts handler for the assembly and test area of its Phoenix, Arizona, plant. The
handler will cost $250,000 to purchase plus $10,000 for installation. If the company undertakes
the investment, it will automate part of the semiconductor test area and reduce operating costs by
$70,000 per year for the next ten years. Five years into the life of the investment, however,
Glentech will have to spend an additional $100,000 to update and refurbish the handler. The
investment in the handler will be depreciated using straight-line depreciation over ten years, and
the refurbishing costs will be depreciated over the remaining five-year life of the handler (also
using straight-line depreciation). In ten years, the handler is expected to be worth $5,000,
although its book value will be zero. Glentech’s tax rate is 30%, and its opportunity cost of
capital is 12%. Exhibit P2-10.1 contains cash flow calculations for the project that can be used in
performing a DCF evaluation of its contribution to firm value. Answer each of the following
questions concerning the project:
a. Is this a good project for Glentech? Explain your answer.
b. What can you tell about the project from the NPV profile found in Exhibit P2-10.1?
c. If the project were partially financed by borrowing, how would this affect the investment cash
flows? How would borrowing a portion of the investment outlay affect the value of the
investment to the firm?
d. The project calls for two investments: one immediately and one at the end of year 5. How
much would Glentech earn on its investment? How should you account for the additional
investment outlay in your calculations?
e. What are the considerations that make this investment somewhat risky? How would you
investigate the potential risks of this investment?
2-11 PROJECT VALUATION HMG Corporation is considering the manufacture of a new
chemical compound that is used to make high-pressure plastic containers. An investment of $4
million in plant and equipment is required. The firm estimates that the investment will have a
five-year life, and will use straight-line depreciation toward a zero salvage value. However, the
investment has an anticipated salvage value equal to 10% of its original cost. The number of
pounds (in millions) of the chemical compound that HMG expects to sell over the five-year life
of the project are as follows: 1.0, 1.5, 3.0, 3.5, and 2.0. To operate the new plant, HMG estimates
that it will incur additional fixed cash operating expenses of $1 million per year and variable
operating expenses equal to 45% of revenues. HMG also estimates that in year t it will need to
invest 10% of the anticipated increase in revenues for year t + 1 in net working capital. The price
per pound for the new compound is expected to be $2.00 in years 1 and 2, then $2.50 per pound
in years 3 through 5. HMG’s tax rate is 38%, and it requires a 15% rate of return on its new-
product investments.
a. Exhibit P2-11.1 contains projected cash flows for the entire life of the proposed investment.
Note that investment cash flow is derived from the additional revenues and costs associated with
the proposed investment. Verify the calculation of project cash flow for year 5.
b. Does this project create shareholder value? How much? Should HMG undertake the
investment? Explain your answer.
c. What if the estimate of the variable costs were to rise to 55%? Would this affect your
decision?

0 1 2 3 4 5
1,000,00 1,500,00 3,000,00 3,500,00 2,000,00
Sales Volume 0 0 0 0 0
Unit Price
Revenues
- - - -
Variable operating 1,350,00 3,375,00 3,937,50 2,250,00
costs -900,000 0 0 0 0
- - - - -
Fixed operating 1,000,00 1,000,00 1,000,00 1,000,00 1,000,00
costs 0 0 0 0 0
Depreciation
expense -800,000 -800,000 -800,000 -800,000 -800,000
Net operating
income
Less:Taxes
NOPAT
Plus: Depreciation
Less: CAPEX 248,000
Less: Working -
Capital 200,000 -100,000 -450,000 -125,000 375,000 500,000
Free cash flow
Net Present Value
IRR