Question 1

A company has two projects to choose from with the following annual after-tax cash flows:

Project A

Investment (today)$700,000

Investment (Year 1) $400,000

Years 28$600,000

Project B

Investment (today)$1,600,000

Years 18$750,000

The firm's cost of capital is 15 percent.

Compute both projects' payback period and discounted payback period.(4 marks)

Question 2

The R.M. Company uses the following risk-adjusted discount rates for capital budgeting purposes:

Investments in new product lines16%

Substitution of labour with capital (machinery)10%

Expansion of existing product lines12%

Replacement of existing equipment8%

The firm has $500,000 of available capital for investment .Project A involves the production of a brand new product line.Project B involves the replacement of existing machinery.Project C involves the purchase of a more sophisticated piece of equipment as a replacement for existing machinery.This more sophisticated machine will enable R.M. Company to reduce the size of its workforce.There are no other projects available at this time.

Expected cash flows for these independent projects are as follows:

Projects

ABC

(in thousands of dollars)

Investment (today)400500100

Net after-tax cash inflows

Year 116013030

Year 215015040

Year 314018050

Year 413021060

Which project(s) would you recommend the company undertake?Show your calculations and provide any necessary explanations.(4 marks)

Question 3

A company has $20 million available to invest in new projects.There are three independent projects that it is considering.The after-tax cash flows of the projects are as follows:

ProjectInvestment (today)Year 1 cash flowYear 2 cash flow

A20 million20 million10 million

B10 million8 million7 million

C10 million6 million10 million

Calculate the IRR, PI and NPV of each of the two-year projects and recommend which project(s) the company should invest in (and why).The company's cost of capital is 15%.(4 marks)

Question 4

You are evaluating two different pollution control devices:

(a)A filtration system which costs $1.1 million to install and $60,000 annually to operate.It would have to be replaced every five years.

(b)A precipitation system which costs $1.9 million to install, but only $10,000 per year to operate.The precipitation equipment has an operating life of eight years.

The company rents its factory and both systems are considered leasehold improvements so straight-line capital cost allowance is used throughout, and neither system has any salvage value.Which system should the company select if the cost of capital is 12% and the tax rate is 40%?Ignore the half-year rule.