Corporate_Finance_9th_edition_Solutions_Manual_FINAL0

To calculate the npv of the decision on the computer

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Unformatted text preview: PV = $100,000 = –$3,200,000 – 75,000 + 1,777,612.09 + OCF (PVIFA13%,4) + [($120,000 + 75,000) / 1.134] Solving for the OCF, we get: OCF = $1,477,790.75 / PVIFA13%,4 = $496,824.68 Now we can solve for the bid price as follows: OCF = $496,824.68 = [(P – v)Q – FC ](1 – tC) + tCD $471,253.44 = [(P – $165)(9,000) – $600,000](1 – 0.40) + 0.40($3,200,000/4) P = $264.41 176 33. a. Since the two computers have unequal lives, the correct method to analyze the decision is the EAC. We will begin with the EAC of the new computer. Using the depreciation tax shield approach, the OCF for the new computer system is: OCF = ($125,000)(1 – .38) + ($780,000 / 5)(.38) = $136,780 Notice that the costs are positive, which represents a cash inflow. The costs are positive in this case since the new computer will generate a cost savings. The only initial cash flow for the new computer is cost of $780,000. We next need to calculate the aftertax salvage value, which is: Aftertax salvage value = $140,000(1 – .38) = $86,800 Now we can calculate the NPV of the new computer as: NPV = –$780,000 + $136,780(PVIFA14%,5) + $86,800 / 1.145 NPV = –$265,341.99 And the EAC of the new computer is: EAC = – $265,341.99 / (PVIFA14%,5) = –$77,289.75 Analyzing the old computer, the only OCF is the depreciation tax shield, so: OCF = $130,000(.38) = $49,400 The initial cost of the old computer is a little trickier. You might assume that since we already own the old computer there is no initial cost, but we can sell the old computer, so there is an opportunity cost. We need to account for this opportunity cost. To do so, we will calculate the aftertax salvage value of the old computer today. We need the book value of the old computer to do so. The book value is not given directly, but we are told that the old computer has depreciation of $130,000 per year for the next three years, so we can assume the book value is the total amount of depreciation over the remaining life of the system, or $390,000. So, the aftertax salvage value of the old computer is: Aftertax salvage value = $230,000 + ($390,000 – 230,000)(.38) = $290,800 This is the initial cost of the old computer system today because we are forgoing the opportunity to sell it today. We next need to calculate the aftertax salvage value of the computer system in two years since we are “buying” it today. The aftertax salvage value in two years is: Aftertax salvage value = $90,000 + ($130,000 – 90,000)(.38) = $105,200 Now we can calculate the NPV of the old computer as: NPV = –$290,800 + $49,400(PVIFA14%,2) + 105,200 / 1.142 NPV = –$128,506.99 177 And the EAC of the old computer is: EAC = – $128,506.99 / (PVIFA14%,2) = –$78,040.97 If we are going to replace the system in two years no matter what our decision today, we should instead replace it today since the EAC is lower. b. If we are only concerned with whether or not to replace the machine now, and are not worrying about what will happen in two years, the correct analysis is NPV. To calculate the NPV of the decision on the computer system now, we need the difference in the total cash flows of the old computer system and the new computer system. From our previous calculations, we can say the cash flows for each computer system are: t 0 1 2 3 4 5 New computer –$780,000 136,780 136,780 136,780 136,780 223,580 Old computer $290,800 –49,400 –154,600 0 0 0 Difference –$489,200 87,380 –17,820 136,780 136,780 223,580 Since we are only concerned with marginal cash flows, the cash flows of the decision to replace the old computer system with the new computer system are the differential cash flows. The NPV of the decision to replace, ignoring what will happen in two years is: NPV = –$489,200 + $87,380/1.14 – $17,820/1.142 + $136,780/1.143 + $136,780/1.144 + $223,580/1.145 NPV = –$136,835.00 If we are not concerned with what will happen in two years, we should not replace the old computer system. 34. To answer this question, we need to compute the NPV of all three alternatives, specifically, continue to rent the building, Project A, or Project B. We would choose the project with the highest NPV. If all three of the projects have a positive NPV, the project that is more favorable is the one with the highest NPV There are several important cash flows we should not consider in the incremental cash flow analysis. The remaining fraction of the value of the building and depreciation are not incremental and should not be included in the analysis of the two alternatives. The $850,000 purchase price of the building is a same for all three options and should be ignored. In effect, what we are doing is finding the NPV of the future cash flows of each option, so the only cash flow today would be the building modifications needed for Project A and Project B. If we did include these costs, the effect would be to lower the NPV of all three options by the same amount, thereby leading to the same conclusion. The cash flows from renting the building after year 15 are also irrelevant. No matter what the company choos...
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This note was uploaded on 07/10/2010 for the course FIN 6301 taught by Professor Eshmalwi during the Spring '10 term at University of Texas-Tyler.

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