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Pet E 411 Jan.

3, 2018
WORK SESSION-10

1. Five alternative proposals have been made for the development of a commercial rental
property. The required land is available on option at a price of $100,000. The following estimates
have been made for the plans:

Annual Disbursements
Investment Annual (Not Including
in Building Receipts Income Taxes)

Plan A $ 80,000 $ 38,900 $ 14,700


Plan B 160,000 65,800 24,200
Plan C 260,000 96,300 33,800
Plan D 364,000 117,800 41,900
Plan E 520,000 145,200 55,000

The estimated life of the building is 40 years with zero terminal salvage value. For the purpose of
this analysis it is to be assumed that this land will be sold for its original cost of $ 100,000 at the end
of a 40-year analysis period. Calculate the before-income tax rate of return for each plan. If the
stipulated before-tax i* is 8% which plan should be selected.

2. Many valves are required in a certain pipeline that carries a corrosive chemical. In the past cast
iron valves have always been used and have required replacement every 2 years. Now valves of
two corrosion-resistant alloys, A and B are available. Estimates of installed first costs, lives and
salvage values for these three types of valve are as follows:

Cast Iron Alloy A Alloy B


First cost $ 2,000 $ 4,000 $ 6,000
Life 2 years 5 years 10 years
Salvage value zero $1,000 zero

The only differences in annual disbursements for the three types of valve are in disbursements for
income taxes. Income tax for each case will be 2.5% of the first cost.

a) At what value of i will the after-tax cost of 10 years of service with the cast iron valve have
exactly the same present worth as the after-tax cost of 10 years of service with valves of Alloy
A? Assume that replacement costs will be the same as original costs.

b) At what value of i will the after-tax cost of 10 years of service with the cast iron valve have
exactly the same present worth as the after-tax cost of 10 years of service with valves of Alloy
B? Assume that replacement costs will be the same as original costs.

c) At what value of i will the after-tax of 10 years of service with the valves of Alloy A have
exactly the same present worth as the after-tax cost of 10 years of service with valves of Alloy
B? Assume that replacement costs will be the same as original costs.

d) If the stipulated after-tax i* is 8%, which type of valve do you recommend? Would your
answer be changed if the stipulated after-tax i* should be 12 %? Explain your reasoning.

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3. A warehouse and terminal company is planning to build a subzero storage warehouse for frozen
foods. The refrigeration engineer, employed by the architect, made a study of four different types
of insulation that might be used and the effects on the cost of refrigeration equipment and
operating costs to determine the most economical plan. The more money that is spent on
insulation material in the walls and roof, the less money that must be spent on refrigeration
equipment and power. The engineer’s estimates are as follows:

Plan A B C D
First cost of insulation material $25,000 35,000 50,000 70,000
First cost of compressors 22,000 17,000 14,000 12,000
First cost of refrigerant piping and coils 20,000 18,000 14,000 10,000
Annual power cost 5,600 4,200 3,200 2,600

The insulation materials are estimated to have a 20-year life with no terminal salvage value. The
compressors, piping and coils are estimated to have a 10-year life with no terminal salvage value.
Property taxes plus insurance will require annual disbursements of 2% of first cost. The stipulated
before-tax- i* is 12%.

a) Compare the before-tax equivalent uniform annual costs for the four alternatives.

b) Analyze the choice among the alternatives by computing rates of return on increments of
investment in B, C and D as compared to A, as well as any other rates of return on increments of
investment that you believe are required to guide a decision. Explain which plan you favor and why
you have chosen it.

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