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E0700237.FIN - E07700237 Question 1 Year Initial 1 2 3 4...

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E07700237 Question 1 Year WB($) SS($) Initial -600,000 -600,000 1 30,000 300,000 2 200,000 300,000 3 300,000 200,000 4 500,000 100,000 i. On project WB, after 3 years the firm will have recaptured $ 530,000 on an initial investment of $600,000, leaving $70,000 of the initial investment still be recouped. During the fourth year, a total of $500,000 will be returned from this investment. Assuming cash will flow into the firm at a constant rate over the year. Thus, the payback period on project WB is (3+ 70,000/ 500,000) = 3.14 years On project SS, after 2 years the firm will have recaptured $ 600,000 on an initial investment of $600,000. Thus, the payback period on project SS is 2 years. The payback period of project SS is shorter than project WB, so time to recapture initial investment is shorter. Therefore, project SS should be chosen. ii. Suppose there is no corporate tax and the cash flows above are income before the depreciation and the firm uses a straight-line depreciation method to zero. 1
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E07700237 Depreciation = $600,000 Accounting rate of return (AROR) AROR = 1 1 2 n t AP n IO SV = + Where AP t = accounting profit in year t IO = the initial outlay SV = the expectation salvage value of the project n = the expected life of the project Accounting profit of WB = (30,000 + 200,000 + 300,000 + 500,000) – 600,000 = $430,000 Accounting profit of SS = (300,000 + 300,000 + 200,000 + 100,000) – 600,000 = $300,000 Thus, 430,000/4 AROR WB = = 0.3583 = 35.83% 600,000/2 300,000/4 AROR SS = = 0.25 = 25% 600,000/2 AROR of WB project is higher than SS project (35% > 25%). Thus, profit return form investment of WB project is higher SS project. Therefore, WB project should be chosen. iii. 2
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E07700237 WB project 600,000 = 1 30,000 (1 ) WB IRR + + 2 200,000 (1 ) WB IRR + + 3 300,000 (1 ) WB IRR + 4 500,000 (1 ) WB IRR + Try IRR WB = 18% = 0.18 1 30,000 (1 18%) + + 2 200,000 (1 18%) + + 3 300,000 (1 18%) + 4 500,000 (1 18%) + =$609,544 Try IRR WB = 19% = 0.19 1 30,000 (1 19%) + + 2 200,000 (1 19%) + + 3 300,000 (1 19%) + 4 500,000 (1 19%) + =$593,802 IRR WB = 18%+ 609,544 600,000 609,544 593,802 - - =18.61%>15% SS project 600,000 = 1 300,000 (1 ) SS IRR + + 2 300,000 (1 ) SS IRR + + 3 200,000 (1 ) SS IRR + + 4 100,000 (1 ) SS IRR + Try IRR SS = 22% = 0.22 1 300,000 (1 22%) + + 2 300,000 (1 22%) + + 3 200,000 (1 22%) + 4 100,000 (1 22%) + =$602,742 Try IRR SS = 23% = 0.23 1 300,000 (1 23%) + + 2 300,000 (1 23%) + + 3 200,000 (1 23%) + 4 100,000 (1 23%) + =$593,364 3
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E07700237 IRR SS =22%+ 602,742 600,000 602,742 593,364 - - =22.29%>15% WB and SS projects can be accepted because the IRR is higher than the required rate of return of 15%. But the IRR of SS project is greater than IRR of WB project. It means the return from investment on SS project is greater than IRR of WB. So, SS project should be chosen. iv . 30,000 200,000 300,000 500,000 NPV WB = + + + - 600,000 (1+ 0.15) 1 (1+ 0.15) 2 (1+ 0.15) 3 (1+ 0.15) 4 = $ 60,447 300,000 300,000 200,000 100,000 NPV SS = + + + - 600,000 (1+ 0.15) 1 (1+ 0.15) 2 (1+ 0.15) 3 (1+ 0.15) 4 = $ 76,391 The NPV in both projects are positive, so they can be accepted. However, NPV SS is higher than NPV WB , so SS project should be chosen. v . 4 IO - + = = N 1 t t t ) k 1 ( FCF NPV IO / ) k 1 ( FCF PI N 1 t t t = + =
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E07700237 PI WB = 1 2 3 4 30,000 200,000 300,000 500,000 (1 15%) (1+15%) (1+15%) (1+15%) 1.1012 1 600,000 + + + + = PI SS = 1 2 3 4 300,000 300,000 200,000 100,000 (1 15%) (1+15%) (1+15%) (1+15%) 1.1277 1 600,000 + + + + = The PI of two projects is greater than 1, so they can be accepted. However, PI SS is higher than PI WB, and then the SS project should be chosen. Question 2 5
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E07700237 Deprciation Schedule % Allowance Depn.Expense($) Deprciation Amount 120,000,000 Year 1 0.1429 17,148,000 Year 2 0.2449 29,388,000 Year 3 0.1749 20,988,000 Year 4 0.1249 14,988,000 Sales Schedule Units Price $ Sale Units Price $ Sale Units $ Sale Year 0 Year 1 880,000 36.00 31,680,000 1,120,000 59.00 66,080,000 2,000,000 97,760,000 Year 2 902,000 37.53 33,852,060 1,142,400 61.51 70,266,168 2,044,400 104,118,228 Year 3 924,550 39.13 36,173,042 1,165,248 64.12 74,717,530 2,089,798 110,890,572 Year 4 947,664 40.79 38,653,156 1,188,553 66.85 79,450,885 2,136,217 118,104,041 OEM Market Replacement Market Total Variable costs Schedule Total units sale VC per unit Total VC Year 0 Year 1 2,000,000 18.00 36,000,000 Year 2 2,044,400 18.77 38,363,166 Year 3 2,089,798 19.56 40,881,699 Year 4 2,136,217 20.39
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