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QUEENS UNIVERSITY KINGSTON, ONTARIO

COMM 244 - SECTIONS A, B and X PROJECT MANAGEMENT AND ECONOMICS SAMPLE TERM TEST 2 INSTRUCTORS This test constitutes 20% of your final mark

INSTRUCTIONS: 1. 2. Time available 2 Hours Answers to ALL questions must be written in the answer booklet that is provided. DO NOT USE RED COLOUR for your presentation in any form, written or pictorial (This colour is reserved for marking your submission) Use of University-approved, non-programmable, non-communicating calculators will be allowed ONLY. Do not remove any pages from the booklet that is provided. Any detached pages must have your name and student number in the top right hand corner. If there is insufficient space, ask the proctor for another answer booklet. Hand in your answer booklet(s) to the proctor before leaving the room. If doubt exists as to the interpretation of any question, the candidate is urged to submit with the answer paper a clear statement of any assumptions made. The proctor or the instructor may not be able to answer your query during the test. Marks will be deducted if appropriate interest factors, their designations and appropriate values of interest rate (i) and period (n) are not indicated. You are strongly encouraged to provide cash flow diagrams where appropriate. There will be penalties if any of the above instructions are not followed

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GOOD LUCK !

INTEREST FACTORS

OTHER FORMULAS Effective interest rates:

Interest Factor

Formula

ia = (1 + r/m)m -1

(F/P, i, n)

(1 + i) n

Depreciation & Taxes DSL = (P-S)/N

(P/F, i, n)

1 (1 + i) n

BSL(n) = P n DSL

(F/A, i, n)

(1 + i )n 1
i

DDB(n) = d P (1-d)n-1, n 1

BDB(n) = P (1-d)n (A/F, i, n)

i (1 + i ) n 1
Inflation

(P/A, i, n)

(1 + i ) n 1 i (1 + i ) n

f_bar = (CPIn/CPI0)1/n -1

R0,N = AN / [(1 + f)N] (A/P, i, n)

i (1 + i ) n (1 + i ) n 1

i = [(1+i) / (1+f)] 1

(A/G, i, n)

1 n i (1 + i ) n 1

Scheduling t = (a+4m+b)/6

(P/G, i, n)

(1 + i ) n in 1 i 2 (1 + i ) n

2 = [(b-a)/6]2 Z= (X-)/

Section 1 (10 Marks) True/False (1 mark will be awarded for each correct answer). Respond to the following questions by writing T (for True) or F (for false in your answer booklet. Do not provide your answer on this test paper. 1. An efficient set of alternative is one where no alternative is dominated. 2. Over the last 5 years, the annualized inflation rate in Canada has been slightly higher than 10%. 3. Actual and constant dollars mean the same thing dollars as measured without the effects of inflation. 4. The CPI is expressed with regards to a base year (currently 1992) where the CPI is equal to 100. 5. Economic depreciation is the systematic allocation of an assets value in portions over its depreciable life. 6. Most firms calculate depreciation in two different ways, depending on whether the calculation is intended for (1) financial reports (book depreciation) or (2) for the purposes of calculating taxes (CCA). 7. Currently, the Canadian Customs and Revenue Agency separates depreciable assets into classes based on their year of purchase. 8. Decision Matrices and the Analytical Hierarchy Process (AHP) are both examples of the application of single-attribute utility theory. 9. Finding the interest rate at which a cash flows present worth turns negative is an example of break-even analysis. 10. The AHP is useful for determining criteria weights, by conducting pair wise comparisons of the criterion.

Section 2 - Problems 11. (20 points) You win the lottery! The prize can either be awarded as $1,000,000 paid out in full today, or yearly instalments paid out at the end of each of the next 10 years. The yearly instalments are $100,000 at the end of the first year, increasing each subsequent year by $5000; in other words you get $100k at the end of the first year, $105k at the end of the second year, $110k at the end of the third, After some economic research you determine that inflation is expected to be 3% for the next 5 years and 5% for the subsequent 5 years. You also discover that real interest rates are expected to be constant at 2% for the next 10 years. a. Using present worth analysis, which prize option do you choose? {Hint: a well-labelled cash flow diagram will probably help you answer this question.} 3

b. Given the inflation figures above, what would be the real value of 1,000,000 in 10 years?

12. (20 points) On her 23rd birthday a young female engineer decides to start saving toward building up a retirement fund that pays 8% nominal interest, compounded quarterly (market interest rate). She feels that $600 000 worth of purchasing power in todays dollars will be adequate to see her through her sunset years after her 63rd birthday. Assume a general inflation rate of 6% per year. a. If she plans to save by making 160 equal quarterly deposits, what should be the amount of her quarterly deposits in actual dollars? b. If she plans to save by making 40 equal yearly deposits, what should be the amount of her yearly deposits, in real dollars?

13. (25 points) Otto-Rentals Ltd. is setting up a new car rental operation. In 2001 they purchase 12 vehicles for a total of $148,000. In year 2002, they buy two more vehicles for $27,000. In year 2003, they sell four vehicles for $29,000, and buy five new cars for $71,000. In year 2004, they sell three vehicles for $16,000. These vehicles belong in CCA Class 16 (d = .50). a. Calculate the Capital Cost Allowance (CCA) for the first four years for this pool of vehicles. b. If Otto-Rentals corporate tax rate is 40%, how much tax is the company saving due to depreciation in the first four years? c. With a real MARR of 8% and an average annual inflation rate of 3%, what is the present value of these tax savings?

14. (25 points). The city of Kingston is installing a new swimming pool on the site of the Large Venue Entertainment Centre. One design being considered is a reinforced concrete pool that will cost $6,000,000 to install. Thereafter, the inner surface of the pool will need to be refinished and painted every 10 years at a cost of $40,000 per refinishing. a. Assuming that the pool will have essentially an infinite life, what is the present worth of the costs associated with the pool design, if the city uses a MARR of 5%? b. How is the present worth affected if the installation costs, refinishing costs and MARR are subject to a 10% increase and decrease? c. To which parameter is the present worth most sensitive? Provide an explanation with your answer.

15. (15 marks). A three-year old small crane is being considered for early replacement. Its current market value is $13,000. Estimated future market values and annual operating costs for the next five years are given in the following table:

Year 0 1 2 3 4 5

Market Value, P 13,000 9,000 8,000 6,000 2,000 0

Annual Operating and Maintenance Cost, O&M 2,500 2,700 3,000 3,500 4,500

a. Using an interest rate of 10% per year, create a table illustrating the Equivalent Annual cost (O&M), Equivalent Annual Cost (Capital), and Equivalent Annual Cost (Total) for the crane for every planning period N, N = 1 to 5 years. b. What is the economic life for this crane at this interest rate? c. If the interest rate doubled, would you expect the economic life to increase or decrease? Explain. -End-