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The Islamic University of Gaza

Industrial Engineering department
Engineering Economy, EIND 4303

Instructor: Dr. Mohammad Abuhaiba, P.E.

Fall 2010 Exam date: 23/01/2011

Final Exam (Open Book) Exam Duration: 2 hours





Question Grade Maximum Grade
1 20
2 9
3 6
4 35
5 30
Total 100
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Question #1 (20 points):
Your Company has purchased a large new truck-tractor for over-the-road use (asset class 00.26). It has a cost
basis of $180,000. With additional options costing $15,000, the cost basis for depreciation purposes is
$195,000. Its MV at the end of five years is estimated as $40,000. Assume it will be depreciated under the
MACRS GDS:
1. What is the cumulative depreciation through the end of year three?
2. What is the MACRS depreciation in the fourth year?
3. What is the BV at the end of year two?

Solution:
From Table 11.2, the truck has a 3-year MACRS class life. Depreciation rates are obtained from Table 11.3 and
listed in the table below.
The amounts of depreciation, cumulative depreciation, and book values are calculated as shown in the table
below.
1. cumulative depreciation through the end of year three = $180,551
2. MACRS depreciation in the fourth year = $14,450
3. BV at the end of year two = $43,329
EOY MV BV
depreciation
rate
dk dk*
0 195000 195000
1 130007 0.3333 64994 64994
2 43329 0.4445 86678 151671
3 14450 0.1481 28880 180551
4 0 0.0741 14450 195000
5 0 0
5 40000 0 0


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Question #2 (9 points):
A special purpose machine is to be depreciated as a linear function of use (units of production method). It costs
$25,000 and is expected to produce 100,000 units and then be sold for $5000. Up to the end of the third year, it
had produced 60,000 units, and during the fourth year it produced 10,000 units. What is the depreciation
deduction for the fourth year and the BV at the end of the fourth year?

Solution:
Depreciation deduction for the fourth year = (10,000/100,000)*(25,000 5,000) = $2000
Cumulative depreciation through the end of year four = (70,000/100,000)*(25,000 5,000) = $14,000
BV at the end of the fourth year = 25,000 14,000 = $11,000












Question #3 (6 points):
The before-tax MARR for a particular firm is 18% per year. The state income tax rate is 5%, and the federal
income tax rate is 39%. State income taxes are deductable from federal taxable income. What is this firm's
after-tax MARR?

Solution:
Effective tax rate = State tax rate + Federal tax rate * (1 - State tax rate)
= 0.05 + 0.39 (1 0.05) = 0.4205
After tax MARR = Before tax MARR * (1 - Effective tax rate) = 0.18*(1 0.4205) = 0.1043 = 10.43%


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Question #4 (35 points):
Two alternative machines will produce the same product, but one is capable of higher-quality work, which can
be expected to return greater revenue. The following are relevant data:
Machine A Machine B
Capital investment $20,000 $30,000
Life 12 years 8 years
Terminal BV (and MV) $4,000 $0
Annual receipts $150,000 $188,000
Annual expenses $138,000 $170,000
Determine which is the better alternative, assuming repeatability and using SL depreciation, an income tax rate
of 40%, and after-tax MARR of 10%.

Solution:

Machine A:
(A/P, 10%, 12) = 0.1468
(A/F, 10%, 12) = 0.0468
Annual depreciation = (20000 4000) / 12 = $1333.33
BTCF = Annual Revenues Annual expenses
Taxable income = BTCF - Annual depreciation
Annual tax amount = 0.40*Taxable income
ATCF = BTCF - Annual tax amount
After tax EUAC
A
= -20,000 (A/P, 10%, 12) + 4000 (A/F, 10%, 12) + 7733 = $4985
Machine A
EOY BV Revenues Expenses dk BTCF
Taxable
Income
Tax ATCF EUAC
0 20000
-
20000

-
20000
-2936
1 150000 138000 1333 12000 10667 4267 7733 7733
2 150000 138000 1333 12000 10667 4267 7733
3 150000 138000 1333 12000 10667 4267 7733
4 150000 138000 1333 12000 10667 4267 7733
5 150000 138000 1333 12000 10667 4267 7733
6 150000 138000 1333 12000 10667 4267 7733
7 150000 138000 1333 12000 10667 4267 7733
8 150000 138000 1333 12000 10667 4267 7733
9 150000 138000 1333 12000 10667 4267 7733
10 150000 138000 1333 12000 10667 4267 7733
11 150000 138000 1333 12000 10667 4267 7733
12 150000 138000 1333 12000 10667 4267 7733
12 0 4000 4000 187
4985

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Machine B:
(A/P, 10%, 8) = 0.18740
Annual depreciation = (30000) / 12 = $3750
BTCF = Annual Revenues Annual expenses
Taxable income = BTCF - Annual depreciation
Annual tax amount = 0.40*Taxable income
ATCF = BTCF - Annual tax amount
After tax EUAC
B
= -30,000 (A/P, 10%, 8) + 12300 = $6678
Machine B
EOY BV Revenues Expenses dk BTCF
Taxable
Income
Tax ATCF EUAC
0 30000
-
30000

-
30000
-5622
1 188000 170000 3750 18000 14250 5700 12300 12300
2 188000 170000 3750 18000 14250 5700 12300
3 188000 170000 3750 18000 14250 5700 12300
4 188000 170000 3750 18000 14250 5700 12300
5 188000 170000 3750 18000 14250 5700 12300
6 188000 170000 3750 18000 14250 5700 12300
7 188000 170000 3750 18000 14250 5700 12300
8 188000 170000 3750 18000 14250 5700 12300
8 0 0 0 0
6678

EUAC
B
> EUAC
A

Therefore, machine B is a better alternative



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Question #5 (30 points):
A truck was purchased four years ago for $65,000 to move raw materials and finished goods between a
production facility and four remote warehouses. This truck (the defender) can be sold at the present time for
$40,000 and replaced by a new tuck (the challenger) with a purchase price of $70,000. Given the MVs and
operating and maintenance costs that follow and if MARR = 10%:
Defender Challenger
EOY Market Value O&M Costs EOY Market Value O&M Costs

1 $30,000 $8,500 1 $56,000 $5,500
2 20,000 10,500 2 44,000 6,800
3 12,000 14,000 3 34,000 7,400
4 4,000 16,000 4 22,000 9,700

1. What is the total marginal cost of the defender if MARR = 10%?
2. What is the economic life of the challenger if MARR = 10%?
3. When the defender should be replaced.

Solution:
Defender
EOY MV
O&M
Costs
Loss in
MV
Forgone Interest Marginal Cost

40000

1 30000 8500 10000 4000 22500
2 20000 10500 10000 3000 23500
3 12000 14000 8000 2000 24000
4 4000 16000 8000 1200 25200

Challenger
EOY MV
O&M
Costs
P/F A/P EUAC

70000

1 56000 5500 0.9091 1.1000 26500
2 44000 6800 0.8264 0.5762 25500
3 34000 7400 0.7513 0.4021 24381
4 22000 9700 0.6830 0.3155 24539

The defender should be kept for three years, then replaced by the challenger.