Fin 3322

Investment Decisions Homework

1. NAU is faced with the decision of which word processor to choose. It can buy the Bang word
processor, which costs $8,000, and has an estimated annua, year!end maintenance cost of $",000.
#he Bang word processor wi be repaced at the end of year $ and ha%e no %aue at the time
&maintenance cost for $ years'.
Aternati%ey, NAU coud buy I(U word processor to accompish the same identica wor). #he
I(U word processor woud need to be repaced after three years. I(U costs ony $*000, but
annua, year!end maintenance costs wi be $"*00 per machine &for three years'.
NAU+s opportunity cost of funds is 1$ percent. Because NAU is a nonprofit institution it does not
pay ta,es. #here is no sa%age %aue for either machine. It is anticipated that whiche%er
manufacturer is chosen now wi be the suppier of future machines. -oud you recommend
purchasing the Bang or I(U.
Since revenue is the same we will compare the costs of the two machines:
Bang: PV Investment ! PV "maintenance costs# $%&&& ! '%$2( )3%$2(
*+, -%(-'./-
I01: PV Investment ! PV "maintenance costs# '%&&& ! '%$&- )&%$&-
*+, -%/'3.//
,hoose I01 machines.
+lternativel2 we can use e3ual hori4ons
B+56
Investment ,osts $%&&& ! $%&&&7).)-8- ! $%&&&7).)-8$ 9)'%'-).))
0p ,osts 9))%32&.'$
:otal ,osts 92/%$/)./;
I01
Investment ,osts '%&&& ! '%&&&7).)-83 ! '%&&&7).)-8/ ! '%&&&7).)-8; 9)2%);&.33
0p ,osts 9)-%)'&.(3
:otal ,osts 92/%3-).&/
+gain choose I01 machines.
". /ompute the cash fows for the pro0ect whose detais are gi%en beow1
#he pro0ect is being set up on and owned by the firm. #his and which is worth $"m now, and was
purchased a year ago for $1m.
#he initia in%estment in pant and machinery wi be $2m. Assume a assets ha%e a ife of * years.
Assume that the sa%age %aue of its pant and machinery wi be $1m.
#he Net -or)ing /apita wi be $1m at the end of year 1 and $"m at the end of year ". At the end of
the pro0ect ife of 3 years, it hopes to reco%er its entire in%estment without oss in %aue.
Its 4B5# are e,pected to be $*m in each of the ne,t 3 years.
#he firm pans to se off its pant and machinery after 3 years for $"m and the and for $3m.
/orporate ta, rate is 3*6. /apita gains ta, rate is "06. #he discount rate is 106.
<r & <r ) <r 2 <r 3
:otal Investment $.&&
7ant 8 9:/ /.&&
;and 2.&&

5et =orking ,apital ).&& 2.&& &.&&

Profit>?oss +ccount
4B5# &$m' '.&& '.&& '.&&
Boo) 5epreciation &$m' ).&& ).&& ).&&
4B# &$m' -.&& -.&& -.&&
#a, &$m' ).33 ).&$ ).3'
Net Income &$m' 2./( 2.;2 2./'

,orporate :a@ ,alculation
#a, 5epreciation &6' 2&.&& 32.&& );.2&
#a, 5epreciation &$m' ).2& ).;2 ).)'
4B# &for ta, purpose' 3.$& 3.&$ 3.$'
#a, &$m' ).33 ).&$ ).3'

,apital 6ains :a@ ,alculation
7roceeds from sae of asset ! 7ant and 9:/ 2.&&
7roceeds from sae of asset ! ;and 3.&&
#a, Boo) <aue of Assets ! 7ant and 9:/ /.&& -.$& 2.$$ ).(3
#a, Boo) <aue of Assets ! ;and 2.&&
7rofit on sae of assets ).2(
/apita =ains #a, &.2'

Summar2 of ,ash Flows
In%estment "$.&&#
/hange in Net -or)ing /apita ").&&# ").&&# 2.&&
Net Income 2./( 2.;2 2./'
Boo) 5epreciation ).&& ).&& ).&&
7roceeds from sae of asset ! 7ant and 9:/ 2.&&
7roceeds from sae of asset ! ;and 3.&&
/apita =ains #a, "&.2'#

Net /ash >ow "$.&&# 2./( 2.;2 )&.-&
7resent <aue "$.&&# 2.-3 2.-) (.$)
-./'
3.?ou ha%e been as)ed to e%auate a pro0ect with infinite ife. @aes and costs are
pro0ected to be $1000 and $*00 respecti%ey. #here is no depreciation and the ta,
rate is 306. #he rea reAuired rate of return is 106. #he infation rate is $6 and
is e,pected to be $6 fore%er. @aes and costs wi increase at the rate of infation.
If the pro0ect costs $3000, what is the N7<.
Sales )%&&& rr )&A
,osts '&& ri -A
:a@ 3&A rn ").)B).&-#>) )-.-A
*B: )%&&&>'&& '&&% +fter ta@es '&& B ")>&.3# 3'& Perpetual cash flow stream
growing at -A
3'& 7 "&.)-->.&-# 3%3/'.3$ >3%&&&
5PV 3/'.3$
$. A pro0ect wi produce operating cash fows of $$*,000 a year for four years. 5uring
the ife of the pro0ect, in%entory wi be owered by $30,000 and accounts
recei%abe wi increase by $1*,000. Accounts payabe wi decrease by
$10,000. #he pro0ect reAuires the purchase of eAuipment at an initia cost of
$1"0,000. #he eAuipment wi be depreciated straight!ine to a Bero boo) %aue
o%er the ife of the pro0ect. #he eAuipment wi be sa%aged at the end of the
pro0ect creating a $"*,000 after!ta, cash fow. At the end of the pro0ect, net
wor)ing capita wi return to its norma e%e. -hat is the net present %aue of
this pro0ect gi%en a reAuired return of 1$6.
<ear & ) 2 3 -
0p ,ash -'%&&& -'%&&& -'%&&& -'%&&&
,hange in
=ork,ap '%&&& >'%&&&
*3uip >)2&%&&& 2'%&&&
Sum >))'%&&& -'%&&& -'%&&& -'%&&& /'%&&&
PV >))'%&&& 3;%-(3./$ 3-%/2/.&- 3&%3(3.(2 3$%-$'.22
5PV 2(%;'$.//
*. 9arsha+s 8 /o. purchased a corner ot in 4gon /ity fi%e years ago at a cost of
$2$0,000. #he ot was recenty appraised at $810,000. At the time of the
purchase, the company spent $*0,000 to grade the ot and another $$,000 to
buid a sma buiding on the ot to house a par)ing ot attendant who has
o%erseen the use of the ot for daiy commuter par)ing. #he company now
wants to buid a new retai store on the site. #he buiding cost is estimated at
$1." miion. -hat amount shoud be used as the initia cash fow for this
buiding pro0ect.
:he proCecteD cost of the EuilDing plus the opportunit2 cost of the lanD
)%2&&%&&& ! $)&%&&& 92%&)&%&&&
2. ?ou own a house that you rent for $1,"00 a month. #he maintenance e,penses on
the house a%erage $"00 a month. #he house cost $8C,000 when you purchased it
se%era years ago. A recent appraisa on the house %aued it at $"10,000. #he
annua property ta,es are $*,000. If you se the house you wi incur $"0,000 in
e,penses. ?ou are deciding whether to se the house or con%ert it for your own
use as a professiona office. -hat %aue shoud you pace on this house when
anayBing the option of using it as a professiona office. #he discount rate is 106.
0pportunit2 costs of selling the house minus the costs associateD with the sale
2)&%&&& F 2&%&&& 9);&%&&&
D. #he pro0ects ha%e the foowing N7<s and pro0ect i%es.
7ro0ect N7< ;ife
7ro0ect A $*,000 $ years
7ro0ect B $D,000 D years
If the cost of capita is 1"6, which pro0ect woud you accept.
ProCect + ProCect B
5 - (
I7< )2A )2A
PV 9'%&&& 9(%&&&
PG: H H
FV & &
*+I 9)%/-/.)( 9)%'33.$2
,hoose ProCect +
8. (9 /onstruction /ompany must choose between two types of cranes. /rane A
costs $200,000, wi ast for * years, and wi reAuire $20,000 in maintenance each
year. /rane B costs $D*0,000 and wi ast for se%en years and wi reAuire
$30,000 in maintenance each year. 9aintenance costs for cranes A and B are
incurred at the end of each year. #he appropriate discount rate is 1"6 per year.
-hich machine shoud (9 /onstruction purchase.
,rane + ,rane B
Purchase /&&%&&& ('&%&&&
0p costs
5 ' (
I7< )2A )2A
PV H H
PG: /&%&&& 3&%&&&
FV & &
PV 92)/%2$/.'( 9)3/%;)2.(&
:otal PV 9$)/%2$/.'( 9$$/%;)2.(&
*+, ,rane + ,rane B
5 ' (
I7< )2A )2A
PV $)/%2$/.') $$/%;)2.(&
PG: H H
FV & &
PG:7 *+, 922/%--'.$2 9);-%33$.3&
Purchase ,rane B
C. Eurt+s Eabinets is oo)ing at a pro0ect that wi reAuire $80,000 in fi,ed assets and
another $"0,000 in net wor)ing capita. #he pro0ect is e,pected to produce saes
of $110,000 with associated costs of $D0,000. #he pro0ect has a $!year ife. #he
company uses straight!ine depreciation to a Bero boo) %aue o%er the ife of the
pro0ect. #he ta, rate is 3*6. -hat is the operating cash fow for this pro0ect.
Depreciation per 2ear $&%&&&7- 2&%&&&
"Sales F ,osts F Depreciation# B ")>ta@# ! Dep 0,F
"))&%&&& F (&%&&& > 2&%&&&# B ")>&.3'# ! 2&%&&& 933%&&&