Expert Chips is a manufacturer of prototype chips based in Austin, Texas. Next year, in 2015, Expert Chips expects to deliver 535 prototype chips at an average price of $110,000. Expert Chips' marketing vice president forecasts growth of 80 prototype chips per year through 2021. That is, demand will be 535 in 2015, 615 in 2016, 695 in 2017, and so on. The plant cannot produce more than 510 prototype chips annually. To meet future demand, Expert Chips must either modernize the plant or replace it. The old equipment is fully depreciated and can be sold for $3,900,000 if the plant is replaced. If the plant is modernized, the costs to modernize it are to be capitalized and depreciated over the useful life of the updated plant. The old equipment is retained as part of the modernize alternative. The following data on the two options are available:

	Modernize		Replace
Initial investment in 2015	$34,800,000		$66,500,000
Terminal disposal value in 2021	$6,500,000		$15,500,000
Useful life	7 years		7 years
Total annual cash operating cost per prototype chip	$91,500		$83,000

Expert Chips uses straight-line depreciation, assuming zero terminal disposal value. For simplicity, we assume no change in prices or costs in future years. The investment will be made at the beginning of 2015, and all transactions thereafter occur on the last day of the year. Expert Chips' required rate of return is 10%. There is no difference between the modernize and replace alternatives in terms of required working capital. Expert Chips pays a 35% tax rate on all income. Proceeds from sales of equipment above book value are taxed at the same 35% rate.

Modernize Alternative - Before Tax Cash Inflows and Outflows
	Units	Net Cash	Initial	Proceeds from
Year	Sold	Contributions	Investments	Sale of Equipment
Jan 1, 2015			$(34,800,000)
Dec 31, 2015	535	$9,897,500
Dec 31, 2016	615	11,377,500
Dec 31, 2017	695	12,857,500
Dec 31, 2018	775	14,337,500
Dec 31, 2019	855	15,817,500
Dec 31, 2020	935	17,297,500
Dec 31, 2021	1,015	18,777,500		$6,500,000

Replace Alternative - Before Tax Cash Inflows and Outflows
	Units	Net Cash	Initial	Proceeds from
Year	Sold	Contributions	Investments	Sale of Equipment
Jan 1, 2015			$(66,500,000)	$3,900,000
Dec 31, 2015	535	$14,445,000
Dec 31, 2016	615	16,605,000
Dec 31, 2017	695	18,765,000
Dec 31, 2018	775	20,925,000
Dec 31, 2019	855	23,085,000
Dec 31, 2020	935	25,245,000
Dec 31, 2021	1,015	27,405,000		15,500,000

1.Sketch the after-tax cash inflows and outflows of the modernize and replace alternatives over the 2015 - 2021 period.

2.Calculate the net present value of the modernize and replace alternatives.

3.Suppose Expert Chips is planning to build several more plants. It wants to have the most advantageous tax position possible. Expert Chips has been approached by Spain, Malaysia, and Australia to construct plants in their countries. Briefly describe in qualitative terms the income tax features that would be advantageous to Expert Chips.