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C H A PT E R 1 7 Capital Budgeting Analysis
b.
What will be its book value (BV) at the end of year three?
c.
Suppose the fork lift can be sold for $10,000 at the end of three
years. What is its after-tax salvage value?
3.
Lisowski Laptops (LL) is examining the possibility of manufac-
turing and selling a notebook computer that is compatible with PC
and Macintosh systems and that can receive television signals. Its
estimated selling price is $2,500. Variable costs (supplies and labor)
will equal $1,500 per unit, and fi xed costs per year would approxi-
mate $200,000. Up-front investments in plant and equipment will
total $270,000, which will be straight-line depreciated over three
years. The initial working capital investment will be $100,000 and
will rise proportionately with sales. Bill, the CEO,
forecasts laptop
sales will be 50,000 units the fi rst year, 60,000 units the second, and
45,000 units the third year, at which time product life cycles would
require closing down production of the model. At that time, the mar-
ket value of the project’s assets will be about $70,000. LL’s tax rate
is 40 percent and its required return on projects such as this one is 17
percent. Should Lisowski Laptops off er the new computer?
4.
Preston Industries’ current sales volume is $100 million a year.
Preston is examining the advantages of electronic data interchange
(EDI). The technology will allow Preston
to electronically commu-
nicate with suppliers and customers and send and receive purchase
orders, invoices, and cash. It will save Preston money by lowering
costs in the purchasing, customer service, accounts payable, and
accounting departments. Initial estimates are that savings will equal
$100,000 a year. Investment in EDI technology will include $500,000
in depreciable expenses and $100,000 in nondepreciable expenses.
Assets will be depreciated on a straight-line basis for four years.
Implementation of EDI is expected to reduce Preston’s
net work-
ing capital by $200,000. Because of changing technology, Preston’s
president, Carol, wants to estimate the eff ect of switching to EDI
on shareholder wealth over a four-year time horizon assuming that
advances in technology will make the equipment worthless at the end
of four years. At a 30 percent tax rate and 13 percent required rate of
return, should Preston Industries switch to EDI?
5.
Bart and Morticia, owners of the prestigious Gomez-Addams
Offi
ce Towers, are concerned about high
heating and cooling costs
and client complaints of temperature variation within the building.
They commissioned an engineering study by Frasco-Prew Associates
to identify the cause of the problems and suggest corrective action.
Frasco-Prew’s basic recommendation is to install a new heating,
ventilation, and air conditioning (HVAC) system, featuring electronic
climate control, in the Towers. Over the next four years, the engineers
estimate a new system will reduce heating and cooling costs by
$125,000 a year. Cost of the new system will be $500,000 and can
be depreciated over four years. Using a 25 percent tax rate and a 14
percent
required return, should Bart and Morticia change the HVAC
system? Use a four-year time horizon.
6.
Casey’s Baseball Bats is planning to export their product to the
Asian market. They estimate up-front expenses of $1 million this year
(year 0) and $3 million next year (year 1). Operating cash fl ows in
years two, three, and four will be (in dollars) $100,000, $200,000, and
$400,000, respectively. After year four, they expect operating cash
fl ows to grow at 10 percent a year indefi nitely. If 15 percent is the
required return on the project, what is its NPV?
7.
The No-Shoplift Security Company
is interested in bidding on
a contract to provide a new security system for a large department
store chain. The new security system would be phased into ten stores
per year for fi ve years. No-Shoplift can purchase the hardware for
$50,000 per installation. The labor and material cost per installation
is approximately $15,000. In addition, No-Shoplift will need to pur-
chase $100,000 in new equipment for the installation, which will be
depreciated to zero using the straight-line method over fi ve years.
This equipment will be sold in fi ve years for $25,000. Finally, an
investment of $50,000 in net working capital will be needed.
Assume
that the relevant tax rate is 34 percent. If the No-Shoplift Security
Company requires a 10 percent return on its investments, what price
should it bid?
