1. Your firm will produce widgets for the next 10 years. Annual revenue from selling widgets is $20,000. Production requires an initial outlay for machinery of $50,000, and involves annual expenses for labor and raw materials of $3,000. In addition, the operation requires the firm to hold a certain amount of inventory. It is estimated that the level of inventory required is 10% of annual sales. You will need to build up this level of inventory before you start the project (i.e., at t=0). The machinery will last 10 years and have zero salvage value. Any remaining assets of the firm will be liquidated at the end of the ten years. Assume that the firm uses straight-line depreciation over the life of the equipment, pays 40% tax and that all cash flows occur at the end of the year.

(i) Calculate the after-tax cash flows for this firm.

(ii) With an 8% cost of capital, what is the NPV of the project? What is the IRR of this project? Should you undertake this project? .

2. Contel Corp. is planning to buy new equipment to test telephone lines. The two manufacturers that currently supply this type of test device are Teltech and Clearline. Teltech's equipment costs $10M and lasts for four years, while Clearline's equipment costs $12M and lasts for five years. Assume that Contel's cost of capital is 10%. Assume that Contel will need to test telephone lines perpetually and prices are expected to stay constant.

Determine whether Contel should buy the testing equipment from Teltech or from Clearline.