Problem 1

REQUIRED INVESTMENT Truman Industries is considering an expansion. The necessary equipment would be purchased for $ 9 million, and the expansion would require an additional $ 3 million investment in working capital. The tax rate is 40%.

a. What is the initial investment outlay?

b. The company spent and expensed $ 50,000 on research related to the project last year. Would this change your answer? Explain.

c. The company plans to use another building that it owns to house the project. The building could be sold for $ 1 million after taxes and real estate commissions. How would that fact affect your answer?

Problem 2

PROJECT CASH FLOW Eisenhower Communications is trying to estimate the first- year net cash flow ( at Year 1) for a proposed project. The financial staff has collected the following information on the project:

Sales revenues $ 10 million

Operating costs ( excluding depreciation) 7 million

Depreciation 2 million

Interest expense 2 million

The company has a 40% tax rate, and its WACC is 10%.

a. What is the project's net cash flow for the first year (t=1)?

b. If this project would cannibalize other projects by $ 1 million of cash flow before taxes per year, how would this change your answer to Part a?

c. Ignore Part b. If the tax rate dropped to 30%, how would that change your answer to Part a?

Problem 3

NET SALVAGE VALUE Kennedy Air Services is now in the final year of a project. The

equipment originally cost $20 million, of which 80% has been depreciated. Kennedy can sell the used equipment today for $5 million, and its tax rate is 40%. What is the equipment's after-tax net salvage value?

Problem 4

REPLACEMENT ANALYSIS The Chang Company is considering the purchase of a new

machine to replace an obsolete one. The machine being used for the operation has a book

value and a market value of zero. However, the machine is in good working order and

will last at least another 10 years. The proposed replacement machine will perform the

operation so much more efficiently that Chang's engineers estimate that it will produce

after-tax cash flows (labor savings and depreciation) of $9,000 per year. The new machine

will cost $40,000 delivered andinstalled, and its economic life is estimated to be 10 years.

It has zero salvage value. The firm's WACC is 10%, and its marginal tax rate is 35%. Should Chang buy the new machine?