Question 1.

Refer to Tables 1 through 4. Add up the total increase in aftertax income for each project. Given what you know about Kay Marsh, to which project do you think she will be attracted?

Aerocomp, Inc. As she headed toward her boss's office, Emily Hamilton, chief operating officer for the Aerocomp Corporation - a computer services firm that specialized in airborne support wished she could remember more of her training in financial theory that she had been exposed to in college. Emily had just completed summarizing the financial aspects of four capital investment projects that were open to Aerocomp during the coming year, and she was faced with the task of recommending which should be selected. What concerned her was the knowledge that her boss, Kay Marsh, a "street smart" chief executive, with no background in financial theory, would immediately favor the project that promised the highest gain in reported net income. Emily knows that selecting projects purely on that basis would be incorrect; but she was not sure of her ability to convince Kay, who tended to assume financiers thought up fancy methods just to show how smart they were As she prepared to enter Kay's office, Emily pulled her summary sheets from her briefcase and quickly reviewed the details of the four projects, all of which she considered to be equally risky A. A proposal to add a jet to the company's fleet. The plane was only six years old and was considered a good buy at $300,000. In return, the plane would bring over S600,000 in additional revenue during the next five years with only about S56,000 in operating costs. (See Table 1 for details) Table 1 Financial analysis of Project A: Add a twin-jet to the company's fleet Initial Expenditures Year Year 2Year 3 Year 5 ear Net cost of new plane Additional revenue Additional operating costs $300,000 $43,000 $76,800 S112,300 $225,000 $168,750 11,250250 250 ,250 1,250 63.000 (450) 38,050 50,750 94,500 31,185 ($13.250) ($450) S25,494 101,003 S63.315 45,000 S66,000 $63,000 $63.000S63,000 ) S31,750 S65,550 $88.494 $164,003 $126,315 ation 5,000 66,000 63,000 63,000 (13,250) 0 Net increase in income Less: Tax at 33% Increase in aftertax income Add back depreciation 0 2,557 49.748 Net c e in cash flow 5300,000 B. A proposal to diversify into copy machines. The franchise was to cost $700,000, which would be amortized over a 40-year period. The new business was expected to generate over $1.4 million in sales over the next five years, and over $800,000 in aftertax earnings. (See Table 2 for details) Table 2 Financial analysis of Project B: Diversify into c machines Initial Year Year 2 Year Year 5 ear Expenditures $700,000 Net cost of new franchise Additional revenue Additional operating costs $87,500 $175,000 $262,500 $393,750 $525,000 26,250 26,250 26,250 26,250 26,250 17,500 43.75031,250 218,750 350,000 481,250 72.188 500 158,813 $29,313 $87,938 S146,563 S234.500 S322438 17,500 17,500 17,500 $17,500 S17,500 $700,000) S46,813 S105,438 $164,063 S252,000 S339.938 17,500 17,500 17.500 17,500 Net increase in income Less: Tax at 33% Increase in aftertax income Add back depreciation 14,438 43313 Net c n cash floW