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You have identified a major improvement to your facility which will require engineering analysis and capital improvements. Your company s tax rate is 3 7

You have identified a major improvement to your facility which will require engineering analysis and capital improvements. Your companys tax rate is 37% and its minimum acceptable rate of recovery is 6.5%. The engineering design labor costs will incur an expense of $400k during the first year and $350k during the second year. The capital improvements will cost $650k during the second year and will have a $35k/year maintenance expense thereafter. The capital costs will be depreciated over 10 years, with double declining balance method for the first 5 years and straight-line depreciation for the second 5 years with no salvage value (do not worry about MACRS or 1/2 year conventions). Once the new equipment is installed, the improvement will result in an increase in revenue by $200k/year beginning in year 3. The equipment has a 20 year life after it is installed.
If the equipment is installed in 2013, during what year will this investment break even?
What is the IRR of this investment?
Is this still an attractive investment even if maintenance costs triple after the equipment has been operating for 10 years? Show why.
By reducing the labor expenses in the design phase, you can reduce this problem to break even in only 10 years after installation of the equipment (during 2023). What is the minimum percent reduction, applied to both years, in those labor expenses to accomplish this?
Assuming the original labor expenses, what percent increase in annual revenue would you need to break even in the 10th year after installation of the equipment?
As an alternative to the original plan, during year 2 of the engineering design, you come up with an engineering modification that will increase revenue improvements by $20k/y but cost an additional $100k of engineering labor during year 2 and $50k of capital investment when the equipment is installed. Is this better than the original plan? Show why.
As an alternative to paying cash for the equipment, you can take out a loan for 80% of the capital cost, to be repaid over 10 years at a 11% interest rate. The principal will be paid back in equal installments.
What is the IRR of the loan option for the original plan?
Using incremental internal rate of return analysis, indicate whether the cash or loan option is better.

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