7-1. Initial costs, year-end cash flows, and desirability measures (net present value and internal rate of return) for mutually exclusive investment being considered by Stockton Corporation follow. The required return is 10 percent. Which investment should be chosen? Why?

year 0 1 2 3 4 np irr

P -1,500 50 400 800 1,000 160 13.60%

Q -1,800 1,200 600 400 50 121 14.55%

7-2

Initial costs, year-end cash flows for two mutually exclusive investments being considered by Stanford Partners follow. The required return is 10 percent. Which investment should be chosen? Why?

Year 0 1 2 3

R -4000 1000 1000 5000 S -5000 5000 1000 1000

7-4 Santa Clara Corporation is consolidating investments T and U. Initial Costs and year-end cash flows follow. Investment T has a life of 3 years and investment U has a life of 4 years. The limiting resource that caused the two investments to be mutually exclusive cannot be reused. The required return is 10 percent. Which investment should be chosen? Why?

Year 0 1 2 3 4

T -50,000 25000 25000 25000

U -65000 25000 25000 25000 25000

7-5 For the mutually exclusive investments described in problem 4, which investment should be chosen if the constraining resource can be reused at the end of either investments life? Why?

7-6 You work as an equipment manager and is considering how often the equipment should be replaced. Suppose a new machine has the following costs over its useful life:

PERIOD Cost comment

(In thousand)

0 $20 purchasing price

1 $1 maintenance cost

2 $1.5 maintenance cost

3 $2.5 maintenance cost

4 $4 maintenance cost

5 $6 maintenance cost

6 $8.5 maintenance cost

7 $12 maintenance cost

The cost of capital is 10%.

a. Determine the optimal time for the machine to be replaced. (Assume that the same machine can be purchased at the same price, ignoring inflation)

b. If you had to buy the machine and rent to the production manager for that machines economic life, what annual rental payment would you have to charge?