PROBLEM 13-1

a. Purchase price of equipment

Additional investment in working capital
Initial investment outlay

9,000,000.00
3,000,000.00
12,000,000.00

b. No, last years $50,000 expenditure is considered a sunk cost and does not represent an incremental
cash flow. Hence, it should not be included in the analysis.

c. The potential sale of the building represents an opportunity cost of conducting the project in that
building. Therefore, the possible after-tax sale price must be charged against the project as a cost.

PROBLEM 13-2
a. Sales revenues
Operating costs
Depreciation
Operating income before taxes
Taxes (40%)
Operating income after taxes
Add back Depreciation
First year project cash flow

10,000,000.00
(7,000,000.00)
(2,000,000.00)
1,000,000.00
(400,000.00)
600,000.00
2,000,000.00
2,600,000.00

b. The cannibalization of existing sales needs to be considered in this analysis on an after-tax basis,
because the cannibalized sales represent sales revenue the firm would realize without the new
project but would lose if the new project is accepted. Thus, the after-tax effect would be to reduce
the projects cash flow by $1,000,000(1 T) = $1,000,000(0.6) = $600,000. Thus, the projects
cash flow would now be $2,000,000 rather than $2,600,000.

c. Sales revenues
Operating costs
Depreciation
Operating income before taxes
Taxes (30%)
Operating income after taxes
Add back Depreciation
First year project cash flow

10,000,000.00
(7,000,000.00)
(2,000,000.00)
1,000,000.00
(300,000.00)
700,000.00
2,000,000.00
2,700,000.00

The projects cash flow would increase by $100,000.

PROBLEM 13-3
Original cost of equipment
Depreciation (80%)
Book value
Selling price
Book value
Gain on sale

20,000,000.00
(16,000,000.00)
4,000,000.00
5,000,000.00
(4,000,000.00)
1,000,000.00

Selling price
Tax on gain (1,000,000 x 40%)
After-tax net salvage value

5,000,000.00
(400,000.00)
4,600,000.00

PROBLEM 13-4
Initial outlay
Present value of cash inflows
1 - (1.10-10)
9,000
0.10
Net present value

(40,000.00)
55,301.10
15,301.10

Chang should buy the new machine because the project has a positive net present value.
PROBLEM 13-5
SYSTEM A
Initial outlay
Present value of cash inflows
1 - (1.10-6)
6,000
0.10
Net present value of System A

(20,000.00)
26,131.56
6,131.56

System A's EAA

-6

6,131.56 /

1 - (1.10 )
0.10

SYSTEM B
Initial outlay
Present value of cash inflows

1,407.85

(12,000.00)

-3

1 - (1.10 )
0.10
Net present value of System B
6,000

14,921.11
2,921.11

System B's EAA

-3

2,921.11 /

1 - (1.10 )
0.10

1,174.62

System A should be chosen because it has a higher EAA than System B.

PROBLEM 13-6
a. Straight-line depreciation
Year 1 (800,000 / 4)
Year 2 (800,000 / 4)
Year 3 (800,000 / 4)

200,000.00
200,000.00
200,000.00

b.

Year 4 (800,000 / 4)

200,000.00

MACRS accelerated depreciation

Year 1 (800,000 x 33%)
Year 2 (800,000 x 45%)
Year 3 (800,000 x 15%)
Year 4 (800,000 x 7%)

264,000.00
360,000.00
120,000.00
56,000.00

Year
1
2
3
4

MACRS - SL
(264,000 - 200,000)
(360,000 - 200,000)
(120,000 - 200,000)
(56,000 - 200,000)

Year
Cash flows PV factor
1
25,600.00
0.909091
2
64,000.00
1.735537
3
(32,000.00) 2.486852
4
(57,600.00) 3.169865
Net present value

Difference
64,000.00
160,000.00
(80,000.00)
(144,000.00)
PV of cash flows
23,272.73
111,074.38
(79,579.26)
(182,584.25)
(127,816.41)

Tax %
40%
40%
40%
40%

Cash flows
25,600.00
64,000.00
(32,000.00)
(57,600.00)