ENG106 Final Soln 11

ENG106 Final Soln 11 - Name (please print) Sal U. Shunn ENG...

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Name (please print) Sal U. Shunn ENG 106 – Engineering Economics Final Winter 2011 You may use eight sheets of hand-written notes. No other reference materials, calculators or other electronic devices are allowed. State any assumptions, show all your work and explain where appropriate. You may use shorthand notation, e.g., (P/A, 5%, 3), where helpful. Do not use Excel functions unless asked to do so. The test has six problems and 100 points. 1. (20 pts) Dewittrite Industries plans to invest $3 million in projects this year. To generate the necessary capital, the corporation plans to borrow $0.8 million from a bank at a before-tax interest rate of 7%/yr, sell bonds worth $1.2 million, and retain $1 million in after-tax earnings. The bonds will cost Dewittrite 9%/yr (before tax), and the corporation’s stockholders expect an 11%/yr rate of return on their investment. Dewittrite’s marginal income tax rate is 43%, and the general inflation rate is 3%/yr. Set up all the relationships needed to determine Dewittrite’s weighted after-tax cost of capital in %/yr. Could set this up as a table: Source B.T. cost, %/yr A.T. cost, %/yr Fraction of total capital Fraction*A.T. cost, %/yr Loan 7% 7%*(1-43%) $0.8/$3 (0.8/3)* 7%*(1-43%) Bonds 9% 9%*(1-43%) $1.2/$3 (1.2/3)* 9%*(1-43%) Retained Earnings 11% $1/$3 (1/3)* 11% Sums: $3/$3 Weighted A.T. cost of capital, %/yr Or as a more compact relationship: Weighted A.T. cost, %/yr ={[(loan cost, %/yr)*loan $ + (bond cost, %/yr)*bond $](1- marginal tax rate) + (equity cost, %/yr)*retained earning $}/total $ of new capital ={[(7%/yr)*$0.8 million + (9%/yr)*$1.2 million](1- 0.43) + (11%/yr)*$1 million}/$3 million 2. (10 pts) Grace & Katherine & Associates have been asked by the IRS to develop a new MACRS depreciation schedule (for tax purposes) by using the following assumptions: eight-year depreciation period, 150% declining balance method with conversion to straight-line, zero salvage value, and half-year convention. Set up the relationship(s) needed to determine the depreciation ($) in the first tax year for an asset with a cost basis of $W. If use 150% DB to begin: D1, $ = (1/2)(1.5/8)($W) Any DB method over 100% will be greater than SL in the first year, but if this is not obvious, could also check for immediate conversion to SL: D1, $ = (1/2)($W - $0)/8 The 150%DB depreciation is larger, so use it in the first tax year.
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2 3. Tahoe City plans to purchase a new snowblower for $500k and wishes to determine how many years the machine should be kept before replacing it. (The machine has a physical life of seven years.) The city expects to
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ENG106 Final Soln 11 - Name (please print) Sal U. Shunn ENG...

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