1.
After the long drought of 1992, the manager of Long Branch Farm is considering
the installation of an irrigation system. The system has an invoice price of
$100,000 and will cost an additional $15,000 to install.
It is estimated that it will
increase revenues by $20,000 annually, although operating expenses other than
depreciation will also increase by $5,000.
The system will be depreciated
straight-line over its depreciable life (5 years) to a zero salvage value.
The
system can actually be sold for an estimated $25,000 at the end of 5 years.
If
the tax rate on ordinary income is 40 percent and the firm’s required rate of
return is 16 percent, should the firm purchase the system?
Why?
Show your
work.
(NPV –$48,266.16;
IRR –2.43%)
2.
Matrix Printers, Inc. is considering entering the laser printing business. An
entirely new plant will be needed which will cost $1,500,000. Land for the plant
will cost an additional $250,000. Both of these costs will be incurred immediately.
The plant will be depreciated straight line over its 15 year life. (Remember the
rule about depreciating land.) In addition to these costs an investment of
$100,000 will be needed for working capital. The plant will generate sales of
$300,000 per year and have associated expenses of $175,000. The firms
marginal tax rate is 34%. The plant will be sold in 15 years for $700,000.
What is
the NPV of making this investment if the required rate of return is 16%. Should
they make the investment?
(NPV = -$1,130,630)
3.
International Soup Company is considering replacing a canning machine.
The
old machine is being depreciated by the straight-line method over a 10-year
recovery period from a depreciable cost basis of $120,000.
The old machine has
5 years of remaining usable live, at which time its salvage value is expected to be
zero, and it can be sold now for $40,000. This machine has a current book value