Question $1$

Your firm is considering launching a new product. The project will cost $$720,000$ to initiate, have a four

year lifespan, and a salvage value of $$80,000.$ Sales are projected at $190$ units per year; the price per

unit will be $$21,000,$ variable costs per unit are $$15,500,$ and fixed costs are $$640,000$ per year. $$50,000$

worth of working capital will need to be invested immediately but this amount will be recovered at the

end of the project. The required rate of return on the project is $14\%,$ the corporate tax rate is $35\%$ and

the CCA rate on the assets required is $20\%.$

a$)$ Should you initiate the project? $(4$ marks$)$

b$)$ What minimum level of sales is required each year for the project to be profitable? $(2$ marks$)$

Question $2$

Mad Cat Inc. is debating between two alternative earth moving machines to use for the next $8$ years.

The first supplier, Double Candle, offers the necessary machinery $($CCA rate $=30\%)$ at an upfront cost of

$$5,450,000.$ These machines are expected to last $4$ years and then be salvaged for approximately

$$1,400,000($the CCA pool remains open$).$ All the Double Candle machines would be salvaged and

replaced after $4$ years. The alternative is to purchase significantly more expensive $($but longer lasting$)$

machinery from Elemental which would last the full $8$ years but cost $$8,650,000$ and depreciate at the

same CCA rate. Elemental's machines have an expected salvage value of approximately $$1,800,000.$

Mad Cat pays a $25\%$ tax rate and its cost of capital is $11\%.$

a$)$ Which of the two systems incurs the lowest overall cost for Mad Cat? $(4$ marks$)$

b$)$ For what salvage value on the Elemental machines would you be indifferent between the two

options? $(2$ marks$)$

Question $3$

Noble House Partners faces a project with unusual cash flows so it has asked you to weigh in on the

value of retaining the option to shut down the project ahead of schedule. The project is one of many the

company is pursuing at the moment and their CFO informs you that they would normally apply a $22\%$

cost of capital to a risky project like this one.

Their CFO explains the project as follows: An initial investment of $$14$ million in assets with a CCA rate of

$30\%($tax rate of $25\%),$ after$-$tax cash flows the first year of $$6$ million. At the end of the first year, we will

get a forecast of next year's value based on market conditions, either positive or negative with a $50\%$

chance of either outcome. If things look positive, in year $2$ cash flows will be $$9$ million after tax and if

they look bad, $$3$ million.

If the project assets can be salvaged for $$9$ million in year $1$ or $$6$ million in year $2,$ how much is

developing the option to shut the project down early $($at t$=1)$ worth to Noble House? $(6$ marks$)$