173PS2W07

# 173PS2W07 - Economics 173 Corporate Finance Prof Garey...

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Economics 173 – Corporate Finance Winter 2006-07 Prof. Garey Ramey Problem Set 2 Problem 2.1. Calculate the cost in PV terms of the following equipment purchases. In each case assume the tax rate is 35%. a. Original cost of \$125,000, depreciated straight-line to an ending book value of \$25,000 at the end of year 5, scrapped at the end of year 5, zero scrap value. Projected inflation rate is zero, OCC is 12%. b. Original cost of \$2 million, depreciated using the five-year tax depreciation schedule (p. 128 of textbook) to an ending book value of zero, scrapped for \$250,000 at the end of year 8. Projected inflation rate is zero, OCC is 7%. c. Original cost of \$750,000, depreciated straight-line to an ending book value of \$150,000 at the end of year 3, scrapped for \$60,000 at the end of year 5, scrap price expressed in today’s dollars. Projected inflation rate is 4%, OCC is 13%. Problem 2.2. Snootjoy Wines is considering the purchase of an automatic winepress for \$160,000. The press will be operated for six years, after which it will be scrapped. At the end of year 6 a scrap value of \$20,000 will be received. Further, a major overhaul of the winepress will be required at the end of year 3, at a cost of \$10,000. For tax purposes, 20% of the initial investment may be depreciated in each year for years 1 through 4, and 10% in years 5 and 6. The overhaul costs may be treated as a current expense. The tax rate is 35% and the OCC is 9%. What is the net cost of this equipment in PV terms? Problem 2.3. Sunset Properties, Inc., is considering investing \$250 million in land that it will hold for 25 years and then resell. The investment generates pretax net cash flows of \$40 million per year, expressed in today’s prices. Land prices are expected to rise at the rate of 7% per year. The OCC is 13%, the projected inflation rate is 2%, and the tax rate is 45%. What is the NPV of this investment? Problem 2.4.

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173PS2W07 - Economics 173 Corporate Finance Prof Garey...

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