FNCE100_PS2 - University of Pennsylvania The Wharton School...

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Unformatted text preview: University of Pennsylvania The Wharton School FNCE 100 A. Craig MacKinlay PROBLEM SET #2 Fall Term 2005 Capital Budgeting Under Certainty 1. (a) Plot the NPV as a function of the interest rate for the following sequences of cash flows: Sequence A Sequence B 1- 100- 100 2 100 3 200 100 4- 100 200 (b) What is the IRR for each sequence? Show this on your graphs. 2. BICCC is considering whether to replace an existing machine or to spend money on overhauling it. The replacement machine would cost $9000 now and would require maintenance of $1000 at the end of every year for 8 years. At the end of 8 years it would have a scrap value of $2000 and would be sold. The existing machine requires increasing amounts of maintenance each year, and its salvage value is falling as shown below: Year Maintenance Salvage Now 4000 1 1000 2500 2 2000 1500 3 3000 1000 4 2000 (The existing machine can be sold for $4000 now. If it is sold in 1 year, the price will be $2500, and $1000 will have to be spent on maintenance. The machine will last for 4 more years before it falls apart.) If BICCC faces an opportunity cost of capital of 15 percent, when should it replace the machine? 3. Five years ago, trucking magnate Leonard Rose purchased ten trucks for $15,000 each. He is now considering replacing those trucks with five new models. One new model can 19 do the work of two of the present trucks. Each new truck will cost $25,000 and has an expected life of ten years with a $1,000 salvage value. It is expected that the current trucks have ten years of service left at the end of which they will have no salvage value. If the five new trucks are purchased, Rose expects total operating expenses for the company to decrease by $10,000 per year. The old trucks could currently be sold for $3,000 each. Taxes are at a 40% rate. The Rose Company uses straight line depreciation. Rose’s costs of capital is 8%. Should he replace the trucks? 4. The H. O. Company is considering purchasing a machine in order to produce a new product. The new product will generate revenues of $50,000 per year for five years. The cost of materials and labor needed to generate these revenues will total $30,000 per year and other cash expenses will be $10,000 per year. Net working capital of $5,000 will be required immediately and this amount will be freed-up at the end of the fifth year. The machine will cost $25,000. It will be depreciated using MACRS for the three year asset class. The three year class depreciates the asset over 4 years as follows: 33.33%, 44.45%, 14.81%, and 7.81%. Finally, the firm’s tax rate is 35% and its required return is 10%. Using the net present value method, determine whether investment in the new machine is economically acceptable....
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FNCE100_PS2 - University of Pennsylvania The Wharton School...

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