TUTORIAL-CAPITAL BUDGETING

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Question 4 Frontier Corporation is considering to replace one of its pieces of equipment with a new, more efficient model. The information with regard to the existing and new proposed equipment is as follows: Existing Equipment New Equipment Purchase price RM500,000 RM800.000 Modification costs RM40,000 Expected life 10 years 6 years Age 4 years Nil Nil Expected salvage value Current salvage value RM150,000 RM60,000 RM15,000 Cost of defects per year Sales RM500,000 RM620,000 RM50,000 RM70,000 Maintenance expenses per year RM100,000 Salary of full-time operator per year No operator is required since it is a fully automated equipment Straight line Straight line Depreciation method The corporate tax rate is 25%. The firm's cost of capital is 15%. Required: (a) Determine the following cash flows associated with the proposed equipment: (i) initial outlay (ii) annual differential cash flows (iii) terminal cash flows (b) Determine the project's: (i) payback period. (ii) NPV. (iii) IRR. (C) Would you accept the project? Explain. Question 14 Sunshine Love Company is considering two mutually exclusive projects, one with a 4-year life and the other 6-year life. The after-tax cash flows from the two projects are as follows: Year Project A (RM) Project B (RM) (400,000) 0 (400,000) 1 162,000 120,000 2 162,000 120,000 3 162,000 120,000 4 162,000 120,000 07 5 120,000 6 120,000 Required: (a) Assuming a 15% required rate of return on both projects, calculate each project's (i) payback period. (ii) NPV. (iii) IRR. (iv) profitability index. (b) Which project should be accepted? Explain