Question #3

A firm believes it can generate an additional $3,000,000 per year in revenues for the next 10 years if it replaces existing equipment that is no longer usable with new equipment that costs $5,000,000. The existing equipment has a book value of $60,000 and a market value of $10,000. The firm expects to be able to sell the new equipment when it is finished using it (after 10 years) for $50,000. Variable costs are expected to be 48% of revenue annually. The additional sales will require an initial investment in net working capital of $300,000, which is expected to be recovered at the end of the project (after 10 years). Assume the firm uses straight line depreciation, its marginal tax rate is 35%, and the discount rate for the project is 10%.

a) How much value will this new equipment create for the firm?

b) At what discount rate will this project break even?

c) Should the firm purchase the new equipment? Be sure to justify your recommendation.

d) How would your analysis change if the firm believes the project is more risky than initially expected? Be specific.

ACT 5733 - Advanced Managerial Accounting Fall 2017 HW #3 Directions: Please submit your work in Word or PDF formats only. Also, please be sure to include your name at the top of the first page of your file. You can use any sources you wish, except for other people. Please be sure to document any source you use. The assignment is due by 11:59 PM on Monday, October 2. Please run spell check and proofread your answers. If you have any questions, please e-mail me at af878@nova.edu or andrew.felo@gmail.com. Good luck! NOTE: This assignment is the intellectual property of Dr. Andrew J. Felo. It may not be posted to any website without the express written consent of Dr. Felo. Question #1 Consider the following potential investment, which has the same risk as the firm's other projects: Time 0 1 2 3 4 5 6 CF ($700,000) $170,000 $180,000 $185,000 $200,000 $205,000 $215,000 a) What are the investment's payback period, IRR, and NPV, assuming the firm's WACC is 12%? b) If the firm requires a payback period of less than 4 years, should this project be accepted? Be sure to justify your choice. c) Based on the IRR and NPV rules, should this project be accepted? Be sure to justify your choice. d) Which of the decision rules (payback, NPV, or IRR) do you think is the best rule for a firm to use when evaluating projects? Be sure to justify your choice. Question #2 Your company is interested in having a new facility constructed. The contractor expects that it will take approximately 3 years to complete the building. The contractor has offered you three payment plans for the building. They are as follows: Time Today 1 year from now 2 years from now 3 years from now Plan 1 $0 $2,610,000 $0 $2,610,000 Plan 2 $720,000 $0 $2,280,000 $2,280,000 Plan 3 $480,000 $1,560,000 $1,560,000 $1,560,000 The CFO of your company has asked you to provide recommendation concerning which payment plan to accept. What is your recommendation? Assume your weighted-average cost of capital is 14% and you have sufficient cash on hand to make any required payments today. Question #3 A firm believes it can generate an additional $3,000,000 per year in revenues for the next 10 years if it replaces existing equipment that is no longer usable with new equipment that costs $5,000,000. The existing equipment has a book value of $60,000 and a market value of $10,000. The firm expects to be able to sell the new equipment when it is finished using it (after 10 years) for $50,000. Variable costs are expected to be 48% of revenue annually. The additional sales will require an initial investment in net working capital of $300,000, which is expected to be recovered at the end of the project (after 10 years). Assume the firm uses straight line depreciation, its marginal tax rate is 35%, and the discount rate for the project is 10%. a) How much value will this new equipment create for the firm? b) At what discount rate will this project break even? c) Should the firm purchase the new equipment? Be sure to justify your recommendation. d) How would your analysis change if the firm believes the project is more risky than initially expected? Be specific