Question 2 (8 marks) UNIT 2: CAPITAL BUDGETTING PROCESS

UNIT 3: CASH FLOW ESTIMATION

a) Adler is replacing its old packing line with a more efficient line. The old line was being depreciated on a straight-line basis at a rate of $20,000 per year. The old machine has a current book

value of $100,000. The new line, which costs $910,000, will be depreciated on a 10-year MACRS

schedule. The more efficient operation is expected to increase revenues by $50,000 per year

and reduce annual operating costs by $80,000. Compute the net cash flows for Adler in year 2. Assume Adler has a marginal tax rate of 40%. Use the rounded MACRS schedule listed below: (10-Year Depreciation Schedule: 10%, 18%, 14%, 12%, 9%, 7%, 7%, 7%, 7%, 6%, 3%) (2 marks)

b) Kaneb is evaluating two alternative pipeline welders. Welder A costs $310,000, has a 7-year life, and is expected to generate net cash inflows of $78,000 in each of the

7 years. Welder B costs $320,000, has a 5-year life, and is expected to generate

annual net cash inflows of $68,900 in each of the 5 years. Kaneb's cost of capital is 16%. Using the equivalent annual annuity method, which alternative should be chosen and what is its NPV? (2 marks)

c) Dorati Inc. is considering two mutually exclusive projects. Dorati used a 15% required rate of return to

evaluate capital expenditure projects. Assuming the two projects have the costs and

cash flows shown below, determine the NPV for each using a replacement chain.

Year Project S Project T

0 $70,000 $100,000

1 $50,000 $ 60,000

2 $60,000 $ 70,000

3 $ 80,000

4 $ 90,000

Assume in two years Project S will still cost $70,000 and produce the same two years of cash flows. (2 marks)