Exercise# 1 :

1. (New project analysis)You have been asked by the president of the Farr Construction
Company to evaluate the proposed acquisition of a new earth mover. The movers basic price is
$50,000, and it would cost another $10.000 to modify it for special use. Assume that the mover
falls into the MACRS 3-year class, it would be sold after 3 years for $20,000, and it would
require an increase in net working capital (spare parts inventory) of $2,000. The earth mover
would have no effect on revenues, but it is expected to save the firm $20,000 per year in before
tax operating costs, mainly labor. The firms marginal federal-plus-state tax rate is 40 percent.

a. What is the net cost of the earth mover? (That is, what are the Year 0 cash flows?)
b. What are the operating cash flows in Years 1, 2, and 3?
c. What are the additional (nonoperating) cash flows in Year 3?
d. If the projects cost of capital is 10 percent, should the earth mover be purchased?

2. (New project analysis) You have been asked by the president of your company to evaluate the
proposed acquisition of a new spectrometer for the firms R&D department. The equipments
basic price is $70,000, and it would cost another $15,000 to modify it for special use by your
firm. The spectrometer, which falls into the MACRS 3-year class, would be sold after 3 years for
$30,000. Use of the equipment would require an increase in net working capital (sapre parts
inventory) of $4,000. The spectrometer would have no effect on revenues, but it is expected to
save the firm $25,000 per year in before tax operating costs, mainly labor. The firms marginal
federal-plus-state tax rate is 40 percent.

a. What is the net cost of the spectrometer? (That is, what are the Year 0 net cash flows?)
b. What are the net operating cash flows in Years 1, 2, and 3?
c. What is the additional (nonoperating) cash flow in Year 3?
d. If the projects cost of capital is 10 percent, should the spectrometer be purchased?

3. (Replacement analysis) The Wingler Equipment Company purchased a machine 5 years ago
at a cost $100,000. It had an expected life on 10 years at the time of purchase and an expected
salvage value of $10,000 at the end of the 10 years. It is being depreciated by the straight line
method toward a salvage value of $10,000, or by $9,000 per year.
A new machine can be purchased for $150,000, including installation costs. Over its 5-year life,
it will reduce cash operating expenses by $50,000 pr year. Sales are not expected to change. At
the end of its useful life, the machine is estimated to be worthless. MACRS depreciation will be
used, and it will be depreciated over its 3-year class life rather than its 5-year economic life.
The old machine can be sold today for $65,000. The firms tax rate is 34 percent. The
appropriate discount rate is 15 percent.

a. If the new machine is purchased, what is the amount of the initial cash flow at Year 0?
b. What incremental operating cash flows will occur at the end of Years 1 through 5 as a result
of replacing the old machine?
c. What incremental nonoperating cash flows will occur at the end of Year 5 if the new machine
is purchased?
d. What is the NPV of this project? Should the firm replace the old machine?