2006 Midterm Exam - Solution

QUESTION 1 - 30 marks (a = b = c = 10)

Assuming a 10% interest rate, find the value of E that makes the disbursements
equivalent to the receipts in each of the following cash flow diagrams.

Part (a) – 10 marks $800 $800 $800

E

0 1 2 3 4

E E
1.5E
SOLUTION

Receipts (upward) at time 1:

PW = E + $800 (P/A, 10%, 3) = E + $800 (2.4869) = E + $1,989.52

Expenditures (downward) at time 1:

PW = E (P/A, 10%, 2) + 1.5E (P/F, 10%, 3) = E (1.7355) + 1.5E (0.75131) =

2.862465E

Equating:

E + $1,989.52 = 2.862465E

E = $1,989.52 / 1.862465
= $1,068.22

Part (b) – 10 marks $120

$90
$60
$30
0 1 2 3 4 5

E E E E E
SOLUTION

E = 30 (A/G, 10%, 5) = 30 (1.8101) = $54.303

Part (c) – 10 marks

$300 $300
$200 $200 $200
$100 $100

0 1 2 3 4 5 6 7

E E

SOLUTION

(c) $300 $300

$200 $200 $200
$100 $100

0 1 2 3 4 5 6 7

E E
P

P = $200 + [$100 + $100 (A/G,10%,3)] (P/A, 10%, 3) + $300 (F/P, 10%, 3) + $200
(F/P, 10%, 2) + $100 (F/P, 10%, 1)

= $200 + [$100 + $100 (0.93656)] (2.4869) + $300 (1.331) + $200 (1.210) + $100
(1.100)

= $1,432.90

E = $1,432.90 (A/P, 10%, 2) = $1,432.90 (0.57619)= $825.62

QUESTION 2 - 20 marks
Clem is saving for a car in a bank account that pays 12% interest, compounded monthly.
The balance is now $2,400. Clem will be saving $120 per month from his salary, and
once every four months (starting in four months) he adds $200 in dividends from an
investment. Bank fees, currently $10 per month, are expected to increase by $1 per month
henceforth ($10 at the end of first month, $11 at the end of the second month and so on).
How much will Clem have saved in two years?
$2400
SOLUTION

$200 $200 $200

$120

1 2 3 4 5 6 7 8 21 22 23 24
$10
$11 $12

G= $1 [4 marks]

Sum the future worth of each individual cash flow:

Balance:
F1 = 2,400(F/P, 1%, 24) = 2,400(1.2697) = $3,047.28 [2 marks]

Salary:
F2 = 120(F/A, 1%, 24) = 120(26.973) = $3,236.76 [2 marks]

Dividends:
ie = (1+0.01)4 – 1 = 4.06 %
F3 = 200(F/A,ie,6) = 200(F/A,4.06%,6) = 200(6.6431) = $1,328.6
[6 marks]
Fee: (Negative cash flow)
F4 = [10+1(A/G, 1%, 24)](F/A, 1%, 24) = [10+1(11.024)] (26.973)
= $567.08 [4 marks]

Total future value = F1 + F2 + F3 - F4 = $7,045.6

Clem will have saved about $7,046.

[2 marks]
QUESTION 3 - 20 marks

The Deadeye Distillery is opening a new production facility at Sweetwater Springs. Two
types of stills are being considered and the following cost estimates have been developed:

Types of Stills
Masher Squeezer
Service Life 4 years 6 years
First Cost $10,000 $15,000
Salvage Value 0 $2,000
Annual Costs $800 in year 1, increasing by $1,000 in year 1, increasing
$200 each year thereafter by $400 each year thereafter

Using present worth analysis with MARR of 25%, which alternative should be selected?
$2,000
SOLUTION
[2 marks]
[2 marks]

0 1 4 0 1 6
$800 $1,000 $1,000
$1,200 $1,400
$1,400 $1,800
$2,200 $2,600
Masher $3,000
10,000
Squeezer
15,000
Analysis Period = 12 Years. MARR = 25%.

MASHER: (need three life cycles).

PW4 = -10,000 - [800 +200(A/G,25%,4)](P/A, 25%, 4)
= -10,000 - [800 +200(1.2249)](2.3616) = - $12,467.8

PW12 = PW4 [1 + (P/F, 25%, 4) + (P/F, 25%, 8)] = - 12,467.8 [1 + (0.4096) + (0.16777)]
= - $19,666.4 [7 marks]
SQUEEZER: (need two life cycles).
PW6 = - 15,000 + [2,000 (P/F, 25%, 6)] - [1,000 + 400(A/G,25%,6)](P/A, 25%, 6)
= - 15,000 + [2,000 (0.26214)] - [1,000 + 400(1.8683)](2.9514)
= - $19,632.76

PW12 = PW6 × [1 + (P/F, 25%, 6)]

= - 19,632.76 [1 + (0.26214)]
[7 marks]
= - $24,779.3

Choose the MASHER since it has the least absolute value of PW. [2 marks]
QUESTION 4 - 15 marks
Caterpillar Corporation wants to build a spare parts storage facility in the Phoenix,
Arizona, vicinity. A plant engineer has identified three different location options. Initial
costs, and annual net cash flow estimates are detailed in the table below. The annual net
cash flow series vary due to differences in maintenance, labor cost, transportation
charges, etc. If the MARR is 10%, use IRR analysis to select the economically best
location if any to be chosen.
Estimates for Three Alternative Building Locations
A B C
Initial cost, $ -275,000 -200,000 -350,000
Annual cash flow, $ +35,000 +22,000 +42,000
Life, years 30 30 30

SOLUTION
Starting with B as a challenger to the Do-Nothing option:

PWB = 0 = -200,000 + 22,000(P/A,i*B,30)

(P/A,i*B,30) = 9.09
From tables:
@ i = 10%: (P/A,10%,30) = 9.4269
@ i = 11%: (P/A,11%,30) = 8.6938

Since i*B falls between 10% and 11% therefore i*B > MARR [5 marks]
Therefore accept B as current best

Comparing A (as a challenger) to B (as a current best):

PW(A-B) = 0 = -75,000 + 13,000(P/A,i*(A-B),30)

(P/A,i*(A-B),30) = 5.7692
From tables:
@ i = 15%: (P/A,15%,30) = 6.5660
@ i = 20%: (P/A,20%,30) = 4.9789 [5 marks]

Since i*(A-B) falls between 15% and 20% therefore i*(A-B) > MARR
Therefore reject B and accept A as current best

Comparing C (as a challenger) to A (as a current best):

PW(C-A) = 0 = -75,000 + 7,000(P/A,i*( C-A),30)

(P/A,i*( C-A),30) = 10.7143
From tables:
@ i = 8%: (P/A,8%,30) = 11.258
@ i = 9%: (P/A,9%,30) = 10.274 [5 marks]

Since i*( C-A) falls between 8% and 9% therefore i*( C-A) < MARR
Therefore reject C and select A as the best location
QUESTION 5 - 15 marks

IQ Computers assembles Unix workstations at its plant just outside St. Catharines,
Ontario. Their current product line is nearing the end of its marketing life, and it is time
to start production of one or more new products. The data for several candidates is shown
below.
The maximum budget for research and development is $300,000. A minimum of
$150,000 should be spent on these projects. It is desirable to spread out the introduction
of new products, so if two products are to be developed together, they should have
different lead times. Resources draw refers to the labor and space that are available to the
new products; it cannot exceed 100%.

Potential Product
A B C D
Research and
$120,000 $60,000 $150,000 $75,000
development costs
Lead time 1 year 2 years 1 year 1.5 years
Resource draw 60% 10% 40% 30%

On the basis of the above information, determine the set of feasible mutually exclusive
alternative projects that IQ Computers should consider.

SOLUTION

Possible Budget Lead Time Resources Feasible?

combinations
Do nothing <$150 000 ok ok no
A <$150 000 ok ok no
B <$150 000 ok ok no
C ok ok ok yes
D <$150 000 ok ok no
AB ok ok ok yes
AC ok same ok no
AD ok ok ok yes
BC ok ok ok yes
BD <$150 000 ok ok no
CD ok ok ok yes
ABC >$300 000 same >100% no
ABD ok ok ok yes
ACD >$300 000 same >100% no
BCD ok ok ok % yes
ABCD >$300 000 same >100% no
[8 marks for table]

There are only seven mutually exclusive projects that IQ Computers

should consider: C, AB, AD, BC, CD, ABD or BCD.

[7 marks (-1 mark for each project wrongly added or missed)]