Problem 6-29 Mutually exclusive investments and project lives As a result of improvements in product engineering, United Automation is able to sell one of its two milling machines. Both machines perform the same function but differ in age. The newer machine could be sold today for $78,500. Its operating costs are $23,800 a year, but at the end of five years, the machine will require a $18,100 overhaul (which is tax deductible). Thereafter, operating costs will be $31,900 until the machine is finally sold in year 10 for $7,850. The older machine could be sold today for $26,900. If it is kept, it will need an immediate $29,500 (tax-deductible) overhaul. Thereafter, operating costs will be $37,900 a year until the machine is finally sold in year 5 for $7,850. Both machines are fully depreciated for tax purposes. The company pays tax at 21%. Cash flows have been forecasted in real terms. The real cost of capital is 11%. a. Calculate the equivalent annual costs for selling the new machine and for selling the old machine. (Do not round intermediate calculations. Enter your answers as a positive value rounded to 2 decimal places.) Equivalent Annual Cost Sell new machine Sell old machine A project requires an initial investment of $100,000 and is expected to produce a cash inflow before tax of $26,700 per year for five years. Company A has substantial accumulated tax losses and is unlikely to pay taxes in the foreseeable future. Company B pays corporate taxes at a rate of 21% and can claim 100% bonus depreciation on the investment. Suppose the opportunity cost of capital is 9%. Ignore inflation. a. Calculate project NPV for each company. (Do not round intermediate calculations. Round your answers to the nearest whole dollar amount.) NPV Company A Company B b. What is the IRR of the after-tax cash flows for each company? (Do not round intermediate calculations. Enter your answers as a percent rounded to 1 decimal places.) IRR Company A % Company B %
Problem 6-29 Mutually exclusive investments and project lives As a result of improvements in product engineering, United Automation is able to sell one of its two milling machines. Both machines perform the same function but differ in age. The newer machine could be sold today for $78,500. Its operating costs are $23,800 a year, but at the end of five years, the machine will require a $18,100 overhaul (which is tax deductible). Thereafter, operating costs will be $31,900 until the machine is finally sold in year 10 for $7,850. The older machine could be sold today for $26,900. If it is kept, it will need an immediate $29,500 (tax-deductible) overhaul. Thereafter, operating costs will be $37,900 a year until the machine is finally sold in year 5 for $7,850. Both machines are fully depreciated for tax purposes. The company pays tax at 21%. Cash flows have been forecasted in real terms. The real cost of capital is 11%. a. Calculate the equivalent annual costs for selling the new machine and for selling the old machine. (Do not round intermediate calculations. Enter your answers as a positive value rounded to 2 decimal places.) Equivalent Annual Cost Sell new machine Sell old machine A project requires an initial investment of $100,000 and is expected to produce a cash inflow before tax of $26,700 per year for five years. Company A has substantial accumulated tax losses and is unlikely to pay taxes in the foreseeable future. Company B pays corporate taxes at a rate of 21% and can claim 100% bonus depreciation on the investment. Suppose the opportunity cost of capital is 9%. Ignore inflation. a. Calculate project NPV for each company. (Do not round intermediate calculations. Round your answers to the nearest whole dollar amount.) NPV Company A Company B b. What is the IRR of the after-tax cash flows for each company? (Do not round intermediate calculations. Enter your answers as a percent rounded to 1 decimal places.) IRR Company A % Company B %
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:Problem 6-29 Mutually exclusive investments and project lives
As a result of improvements in product engineering, United Automation is able to sell one of its two milling machines. Both
machines perform the same function but differ in age. The newer machine could be sold today for $78,500. Its operating costs
are $23,800 a year, but at the end of five years, the machine will require a $18,100 overhaul (which is tax deductible).
Thereafter, operating costs will be $31,900 until the machine is finally sold in year 10 for $7,850.
The older machine could be sold today for $26,900. If it is kept, it will need an immediate $29,500 (tax-deductible) overhaul.
Thereafter, operating costs will be $37,900 a year until the machine is finally sold in year 5 for $7,850.
Both machines are fully depreciated for tax purposes. The company pays tax at 21%. Cash flows have been forecasted in real
terms. The real cost of capital is 11%.
a. Calculate the equivalent annual costs for selling the new machine and for selling the old machine. (Do not round
intermediate calculations. Enter your answers as a positive value rounded to 2 decimal places.)
Equivalent Annual
Cost
Sell new machine
Sell old machine
Transcribed Image Text:A project requires an initial investment of $100,000 and is expected to produce a cash inflow before tax of $26,700 per year
for five years. Company A has substantial accumulated tax losses and is unlikely to pay taxes in the foreseeable future.
Company B pays corporate taxes at a rate of 21% and can claim 100% bonus depreciation on the investment. Suppose the
opportunity cost of capital is 9%. Ignore inflation.
a. Calculate project NPV for each company. (Do not round intermediate calculations. Round your answers to the nearest
whole dollar amount.)
NPV
Company A
Company B
b. What is the IRR of the after-tax cash flows for each company? (Do not round intermediate calculations. Enter your answers
as a percent rounded to 1 decimal places.)
IRR
Company A
%
Company B
%
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