4. Consider the following statments: " We like to do all our capital dudgeting calculations in real terms.It saves making any forecasts of the inflation rate. " Disuss briefly.
6. Mrs. T. Potte, the treasurer of Ideal China, has a problem. The company has just ordered a new kilg for $400,000. Of this sum, $50,000 is described by the supplier as an installation cost.
Mrs. Potts does not know whather the Internal Revenue Service will permit the company to treat this cost as a tax-deductible curreas expense or as a capital investment In the latter case, the company could depreciate the $50,000 sing 5-year tax depreciation schedule. If the tax rate is 35 percent and the opportunity cost of capital is 5 percent will is the PV of the tax arceld in either case ?
8. Hayden Inc. has a number of copiers that were bought four years ago for $20,000 curnently maintenance cost $2,000 a year, but the maintenance agreement explres at the end of two years and thereafter the annual maintenance charge will rise to $8,000 The machines have a current resale value of $8,000, but at the end of year 2 their value will have fallen $3,500. by the end of year of the machines will be valueless and would be scrapped. Hayden is considering replacing the copiers with new machine that would to esserntfally the same job. These machines cost $25,000, and the company can take out on eight-year maintenance contract for $1,000
The machinces have no value by the end of the eight years and would be scrapped. Both manchines are depreciated by using seven-year MACRS, and the tax rate is 35 percent, Assume for simplicity that the inflation rate si zero. the real cost of capital is 7 percent.
When should Hayden replace its copiers?
10. A widget manufacturer currently produces 200,000 units a year. It buys widget lids from an outside supplier at a price of $2 a lid. The plant manager belives that it would be cheaper to make these lids rather than buy them. Direct production costs are estimated to be only $1.50 a lid. The necessary machinery would cost $150,000. This inwestmant could be written off for tax purposes using the seven-year tax depreciation schedule The plant manager estimates that the operation would since it is recoverable at the end of the 10 year. If the company pays tax at a rate of 35 percent and the opportunity cost of capital is 15 percent, would you support the plant manager's proposal? State clearly any additional assumption that you need to make.
12. United Pigpen is considering a proposal to manutacture high-proten hog feed. The project would make use of am exsting warehous, which is currently rented out to a neighboring firm. The next year's nental charge on the warehouse is $100,000, and thereafter the rent is expected to grow in line with inflation at 4 percent a year. In addition to using the warehouse the proposal envisages an investment in plant and equtpment of $1.2 million, This could be depreciated for tax purposes straight-line over 10 years. However, Pigpen expects to terminake the project at the end of eight years and to resell the plant and equipment in year 8 for $400,000 Finally, the project requires an initial inwestment is working capital of $350,000,
Thereafter, working capital is forecast to be 10 percent of sales in each of years 1 through 7. Year 1 sales of hog feed are expected fo be $4.2 million, and thereafter asles are forecast to grow by 5 percent a year, slightly faster than the inflation rate. Manufacturing costs are expected to be 90 percent of sales, and profits are subject to tax at 35 percent. The cost of capital is 12 percent.
What is the NPV of Pigpen's project?