Chapter 15 PDF

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park.
ISBN: 0-13-611848-8
2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
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Chapter 15 Capital-Budgeting Decision

Methods of Financing
15.1
(a) Equity Financing:
Let X denote the number of shares to be sold. The total flotation cost would be
(0.06)($25) X = $1.5 X
To net $10 million,
25 X 1.5 X = $10, 000, 000

23.5 X = $10, 000, 000
X = 425,532 shares
Flotation cost = $638,298
(b) Equity Financing:
$10, 000, 000

$10, 000, 000 = $193, 680
1 0.019
Number of bond = $10,193,680 / $1,000 = 10,194 units
Annual interest = (10,194)($1,000)(0.12) = $1,223,280
Flotation cost =
15.2
(a) Equal repayment of the principal:
n
0
1
2
3
4
5
6
Repayment
Interest
Principal
$45,000
$37,500
$30,000
$22,500
$15,000
$7,500
$83,333
$83,333
$83,333
$83,333
$83,333
$83,333
Loan Balance
$500,000
$416,667
$333,333
$250,000
$166,667
$83,333
$0
Page | 1
Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

(b) Equal repayment of the interest:

n
0
1
2
3
4
5
6
Repayment
Interest
Principal
$45,000
$45,000
$45,000
$45,000
$45,000
$45,000
$0
$0
$0
$0
$0
$500,000
Loan Balance
$500,000
$500,000
$500,000
$500,000
$500,000
$500,000
$0
(c) Equal annual installment:
A = $500, 000( A / P,9%, 6) = $111, 460

n
0
1
2
3
4
5
6
Repayment
Interest
Principal
$45,000
$39,019
$32,499
$25,392
$17,646
$9,203
$66,460
$72,441
$78,961
$86,068
$93,814
$102,257
Loan Balance
$500,000
$433,540
$361,099
$282,138
$196,070
$102,257
$0
15.3
(a) Equity Financing
Income Statement
Revenue
$100,000 $100,000 $100,000 $100,000
Expenses
Depreciation
$40,000
$64,000
$38,400
$11,520
Taxable Income
$60,000
$36,000
$61,600
$88,480
Income Taxes
$21,000
$12,600
$21,560
$30,968
Net Income
$39,000
$23,400
$40,040
$57,512
Page | 2

Cash Flow Statement

Cash from operation
Net Income
$39,000
$23,400
$40,040
$57,512
Depreciation
$40,000
$64,000
$38,400
$11,520
Investment/Salvage
($200,000)
$30,000
Gains Tax
$5,628
Net cash flow
($200,000)
PW(10%) =
$74,467
AE(10%) =
$23,492
$79,000
$87,400
$78,440
$104,660
(b) Debt Financing

Income Statement (Bank A)
Revenue
Expenses
Depreciation
Interest
1
2
3
4
$100,000 $100,000 $100,000 $100,000
$40,000
$20,000
$64,000
$15,000
$38,400
$10,000
$11,520
$5,000
Taxable Income
Income Taxes
$40,000
$14,000
$21,000
$7,350
$51,600
$18,060
$83,480
$29,218
Net Income
$26,000
$13,650
$33,540
$54,262
$26,000
$40,000
$13,650
$64,000
$33,540
$38,400
$16,000
$27,650
$21,940
Cash Flow Statement

Cash from operation
Net Income
Depreciation
Investment/Salvage
Gains Tax
Loan Repayment
Net cash flow
$54,262
$11,520
($200,000)
$30,000
$5,628
$200,000 ($50,000) ($50,000) ($50,000) ($50,000)
$0
PW(10%) =
$88,994
AE(10%) =
$28,075
Income Statement (Bank B)

Revenue
Expenses
Depreciation
Interest
Taxable Income
Income Taxes
Net Income
$26,000
$51,410
1
2
3
4
$100,000 $100,000 $100,000 $100,000
$40,000
$20,000
$64,000
$16,724
$38,400
$13,121
$11,520
$9,157
$40,000
$14,000
$19,276
$6,747
$48,479
$16,968
$79,323
$27,763
$12,529
$31,511
$51,560
$54,262
Page | 3

Cash Flow Statement

Cash from operation
Net Income
Depreciation
Investment/Salvage
Gains Tax
Loan Repayment
$26,000
$40,000
$12,529
$64,000
$31,511
$38,400
$51,560
$11,520
($200,000)
$30,000
$5,628
$200,000 ($32,759) ($36,035) ($39,638) ($91,566)
$33,241
$40,494
$30,273
Net cash flow
$0
PW(10%) =
$91,307
AE(10%) =
$28,805
$7,142
(c) Best course of action: Adopt Bank Bs repayment plan

15.4
(a) The total flotation costs to raise $65 million:
Common stock:
amount of common stock = ($65, 000, 000)(0.45)
= $29, 250, 000

$29, 250, 000
flotation cost =
$29, 250, 000 = $1, 410,377
1 0.046
Preferred stock:
amount of preferred stock = ($65, 000, 000)(0.10)
= $6,500, 000
flotation cost =
$6,500, 000
$6,500, 000 = $572,905
1 0.081
Bond:
amount of bond = ($65, 000, 000)(0.45)
= $29, 250, 000
$29, 250, 000
flotation cost =
$29, 250, 000 = $415,314
1 0.014
Total flotation costs = $2,398,596
(b) Number of shares or (bonds) to be sold to raise $65 million:

Common stock:
X S (1 0.046)($32) = $29, 250, 000
X S = 958,137 shares
Page | 4

Preferred stock:
X P (1 0.081)($55) = $6,500, 000
X P = 128,598 shares
Bond:
X B (1 0.014)($980) = $29, 250, 000
X B = 30, 271 units
(c) Cash requirement to meet financing costs:

Common stock:
annual cash dividends = ($2 / share)(958,137 shares)
= $1,916, 274
Preferred stock:
annual cash dividends = (0.06)($15 / share)(128,598shares)
= $115, 738
Bond:
borrowing amount = (30, 271)($1, 000)
= $30, 271, 000
annual interest = ($30,271,000)(0.12) = $3,632,520
Total annual cash requirement = $5,664,532
Cost of Capital
15.5 After-tax cost of debt:
(a) (0.12)(1 0.25) = 0.09 or 9%
(b) (0.14)(1 0.34) = 0.0924 or 9.24%
(c) (0.15)(1 0.40) = 0.09 or 9%
Page | 5

15.6
To provide a yield to maturity of 13% to the bond investors, the bond offering price
should be
P = $110( P / A,13%,10) + $1, 000( P / F ,13%,10)
= $891.48
Now to raise $10 million, The Sweeny would have to sell

$10, 000, 000
= $10,193, 680
1 0.019
Since the $1,000 bond will be sold at a 10.852% discount, the total number of bonds
to be sold would be
$10,193, 680
= 11, 434.56.
891.48
The annual debt interest payment on after-tax basis would be
11, 434,56($1, 000)(0.11)(1 0.35) = $817,571
15.7 Cost of retaining earnings:

kr =
$1.12
+ 0.12 = 18.22%
$18
15.8
(a) Flotation costs in percentage:
fc = 1
15
= 16.67%
18
(b) Cost of new common stock:

ke =
15.9
$1.10
+ 0.10 = 17.33%
$18(1 0.1667)
ie = 0.22
id = (0.13)(1 0.40) = 0.078
k = (0.078)(0.45) + (0.22)(0.55)
= 0.1561
Page | 6

15.10
Given: ke = 0.30
(a)
ie = (70 / 70)(0.30) = 0.3
id = (1 0.40)[(10 / 30)(0.14) + (20 / 30)(0.12)] = 0.076
k = (0.076)(0.30) + (0.3)(0.70) = 0.2328
(b)
ie = r f + rM r f = 0.06 + 1.2(0.12 0.06) = 0.132
(c)
k = (0.076)(0.30) + (0.132)(0.70) = 0.1152

15.11 Given: ie = 18%, id = (0.12)(1 0.36) = 0.0768
k = (0.4)(0.0768) + (0.6)(0.18) = 13.87%
(a) Net equity flow method:
PW (18%) = $35,847 > 0 , accept the project.
0
1
2
Income Statement
$90,000 $90,000
Revenue
Expenses
$10,000 $10,000
O&M
$28,580 $48,980
Depreciation
$9,600 $8,089
Interest
$90,000 $90,000 $90,000

$10,000 $10,000 $10,000
$34,980 $24,980 $8,930
$6,396 $4,501 $2,378
Taxable Income
Income Taxes
$41,820 $22,931 $38,624 $50,519 $68,692

$15,055 $8,255 $13,904 $18,187 $24,729
Net Income
$26,765 $14,676 $24,719 $32,332 $43,963
Cash Flow Statement

Cash from operation
$26,765 $14,676 $24,719 $32,332 $43,963
Net Income
$28,580 $48,980 $34,980 $24,980 $8,930
Depreciation
($200,000)
$50,000
Investment/Salvage
$1,278
Gains Tax
$80,000 ($12,593) ($14,104) ($15,796) ($17,692) ($19,815)
Loan Repayment
($120,000) $42,752 $49,552 $43,903 $39,620 $84,356
Net cash flow
PW(18%) = $35,847
Page | 7

(b) Cost of capital method:

PW (13.87%) = $41,300 > 0 , accept the project.
0
Income Statement
Revenue
Expenses
O&M
Depreciation
$90,000 $90,000 $90,000 $90,000 $90,000

$10,000 $10,000 $10,000 $10,000 $10,000
$28,580 $48,980 $34,980 $24,980 $8,930
.
Taxable Income
Income Taxes
$51,420 $31,020 $45,020 $55,020 $71,070

$18,511 $11,167 $16,207 $19,807 $25,585
Net Income
$32,909 $19,853 $28,813 $35,213 $45,485
Cash Flow Statement

Cash from operation
Net Income
Depreciation
Investment/Salvage
Gains Tax
$32,909 $19,853 $28,813 $35,213 $45,485

$28,580 $48,980 $34,980 $24,980 $8,930
($200,000)
$50,000
$1,278
Net cash flow

($200,000) $61,489 $68,833 $63,793 $60,193 $105,693
PW(13.87%) = $41,300
15.12
(a) Net equity flow method:
0
Income Statement
Revenue
Expenses
Depreciation
Interest (15%)
1
2
3
4
5
$45,000 $45,000 $45,000 $45,000 $45,000
$20,000 $32,000 $19,200 $11,520
$9,000 $7,665 $6,130 $4,365
$5,760
$2,335
Taxable Income
Income Taxes (30%)
$16,000 $5,335
$4,800 $1,600
$19,670 $29,115 $36,905

$5,901 $8,735 $11,072
Net Income
$11,200 $3,734
$13,769 $20,381 $25,834
Cash Flow Statement

Cash from operation
Net Income
Depreciation
Investment/Salvage
Gains Tax
Loan Repayment
$11,200 $3,734 $13,769 $20,381 $25,834

$20,000 $32,000 $19,200 $11,520 $5,760
($100,000)
$30,000
($5,544)
$60,000 ($8,899) ($10,234) ($11,769) ($13,534) ($15,564)
Net cash flow
($40,000) $22,301 $25,501 $21,200 $18,366 $40,485
PW(20%) =
$33,689
The project is acceptable.
Page | 8

(b) Cost of capital method:

ie = 20%, id = (0.15)(1 0.30) = 0.105
k = (0.6)(0.105) + (0.4)(0.2) = 14.3%
0
Income Statement
Revenue
Expenses
Depreciation
1
2
3
4
5
$45,000 $45,000 $45,000 $45,000 $45,000
$20,000 $32,000 $19,200 $11,520
$5,760
Taxable Income
Income Taxes
$25,000 $13,000 $25,800 $33,480 $39,240

$7,500 $3,900 $7,740 $10,044 $11,772
Net Income
$17,500
$9,100 $18,060 $23,436 $27,468
Cash Flow Statement

Cash from operation
Net Income
Depreciation
Investment/Salvage
Gains Tax
$17,500 $9,100 $18,060 $23,436 $27,468

$20,000 $32,000 $19,200 $11,520 $5,760
($100,000)
$30,000
($5,544)
Net cash flow
($100,000) $37,500 $41,100 $37,260 $34,956 $57,684
PW(14.3%) =
$39,268
The project also is acceptable.
15.13
(a) Using ie = 15% :
Machine A
Income Statement
Revenue
Expenses
O&M
Depreciation
Interest(10%)
1
2
3
4
5
6
$20,000 $20,000 $20,000 $20,000 $20,000 $20,000
$8,000
$8,000
$1,200
$8,000
$12,800
$1,044
$8,000
$7,680
$873
$8,000
$4,608
$685
$8,000
$4,608
$478
$8,000
$2,304
$250
Taxable Income
Income Taxes (35%)
$2,800
$980
($1,844)
($646)
$3,447
$1,206
$6,707
$2,347
$6,914
$2,420
$9,446
$3,306
Net Income
$1,820
($1,199)
$2,240
$4,359
$4,494
$6,140
Cash Flow Statement

Cash from operation
Net Income
$1,820 ($1,199) $2,240 $4,359 $4,494 $6,140
Depreciation
$8,000 $12,800 $7,680 $4,608 $4,608 $2,304
Investment/Salvage
($40,000)
$4,000
Gains Tax
($1,400)
Loan Repayment
$12,000 ($1,555) ($1,711) ($1,882) ($2,070) ($2,277) ($2,505)
Net cash flow
($28,000) $8,265
PW(15%) = $2,979
$9,890
$8,038
$6,897
$6,825
$8,539
Page | 9

Machine B
Income Statement
Revenue
Expenses
O&M
Depreciation
Interest (10%)
1
2
3
4
5
6
$28,000 $28,000 $28,000 $28,000 $28,000 $28,000
$10,000 $10,000 $10,000 $10,000 $10,000 $10,000
$12,000 $19,200 $11,520 $6,912 $6,912 $3,456
$1,800 $1,567 $1,310 $1,028
$717
$376
.
Taxable Income
Income Taxes (35%)
$4,200
$1,470
($2,767)
($968)
$5,170
$1,809
$10,060 $10,371 $14,168

$3,521 $3,630 $4,959
Net Income
$2,730
($1,798)
$3,360
$6,539
$6,741
$9,209
Cash Flow Statement

Cash from operation
Net Income
$2,730 ($1,798) $3,360 $6,539 $6,741 $9,209
Depreciation
$12,000 $19,200 $11,520 $6,912 $6,912 $3,456
Investment/Salvage
($60,000)
$8,000
Gains Tax
($2,800)
Loan Repayment
$18,000 ($2,333) ($2,566) ($2,823) ($3,105) ($3,416) ($3,757)
Net cash flow
($42,000) $12,397 $14,835 $12,058 $10,346 $10,237 $14,108
PW(15%) = $5,030
Machine B should be better.
(b) Using k = 0.7(0.15) + 0.3(0.10)(1 0.35) = 12.45% :

Machine A
Income Statement
Revenue
Expenses
O&M
Depreciation
1
2
3
4
5
6
$20,000 $20,000 $20,000 $20,000 $20,000 $20,000
$8,000
$8,000
$8,000
$12,800
$8,000
$7,680
$8,000
$4,608
$8,000
$4,608
$8,000
$2,304
Taxable Income
Income Taxes (35%)
$4,000
$1,400
($800)
($280)
$4,320
$1,512
$7,392
$2,587
$7,392
$2,587
$9,696
$3,394
Net Income
$2,600
($520)
$2,808
$4,805
$4,805
$6,302
Cash Flow Statement

Cash from operation
Net Income
$2,600
Depreciation
$8,000
Investment/Salvage
($40,000)
Gains Tax
($520)
$12,800
$2,808
$7,680
$4,805
$4,608
$4,805
$4,608
$6,302
$2,304
$4,000
($1,400)
($40,000) $10,600 $12,280 $10,488
$9,413
$9,413
$11,206
Net cash flow
PW(12.45%) = $3,178
Page | 10

Machine B
Income Statement
Revenue
Expenses
O&M
Depreciation
1
2
3
4
5
6
$28,000 $28,000 $28,000 $28,000 $28,000 $28,000
$10,000 $10,000 $10,000 $10,000 $10,000 $10,000
$12,000 $19,200 $11,520 $6,912 $6,912 $3,456
.
Taxable Income
Income Taxes (35%)
$6,000
$2,100
Net Income
$3,900
($1,200) $6,480
($420) $2,268
$4,212
$7,207
$7,207
$9,454
Cash Flow Statement

Cash from operation
Net Income
$3,900 ($780) $4,212
Depreciation
$12,000 $19,200 $11,520
Investment/Salvage
($60,000)
Gains Tax
$7,207
$6,912
$7,207
$6,912
$9,454
$3,456
$8,000
($2,800)
Net cash flow
($780)
$11,088 $11,088 $14,544

$3,881 $3,881 $5,090
($60,000) $15,900 $18,420 $15,732 $14,119 $14,119 $18,110
PW(12.45%) = $5,410
Machine B should still be better.
(c) Both methods provide the same decision.
Capital Budgeting
15.14 Based on the investment opportunity curve below, the firms optimal capital
budget would be $177 million, if there is no restriction on the firms debt limit.
However, with a budget limit of $100 million, the firm may select projects 5
and 3 first. Since these two projects alone consume $95 million, the firm may
have two choices about utilizing the remaining $5 million funds. First one is to
find any projects whose rates of return exceed the cost of capital. Project 4
comes close to meeting this requirement. However, the firms borrowing rate is
18%, which is greater than the rate of return from project 4. Therefore, the
projects that should be included in the $100 million budget would be projects 5
and 3. If money has to be raised from outside, the firm should raise only $95
million.
Page | 11

Rate of Return
90%
5
80%
3
40%
2
32% 30%
7
22%
15%
rate
Borrowing
(18%)
Lending (12%)
Capital budget ($ Million)

15.15
(a) Present worth analysis: With no budget restriction, select alternatives
1,2,3,4,7,13, and 14. The total NPW from the projects is $2,196.
j
1
2
3
4
5
6
7
PW(8%)
$303
$501
$661
$46
-$66
-$814
$47
j
8
9
10
11
12
13
14
PW(8%)
-$208
-$165
-$272
-$1,017
-$248
$126
$512
(b) With a budget limit of $1,800, select alternatives 1, 2, 3,4,13, and 14. The total
amount of investment required is $1,756.
Page | 12

Short Case Studies

ST 15.1
(a)
Total market value = Present value of its expected future net cash flows +
the value of current assets ($5M)
Total market value =stock price per share* number of share outstanding
= $18(1M) = $18M
Present value of its expected future net cash flows = $13M
(b)
Income before tax = $3.5M

Earnings = $2.1M
Income before tax (1-tax rate) = Earnings
Tax rate = 40%
(c)
The case when the financing source is known, we use interest rate of equity
( ie ) as MARR, MARR = ie
c
ie = c ke , since we have only one source of equity, issuing common new
ce
stocks
Debt to equity ratio = total debt/ total equity = 12000/18000 = 2/3
Games Inc. intends to maintain its current debt to equity ratio when financing
to purchase new equipment. Therefore, they will be financing the cost of new
equipment, $10M, the amount of $4M from debt of long term debt and $6M
from equity of stock.
Therefore, cc = ce = $6M
D1 = D0 (1 + g) =1.9(1+0.225) = $2.3275, P0 = 1.8, fc = 0.11
g with the average dividend from 2004 to 2009

1/4
1.9
g=
1
ke =
1 = 0.174
D1
+ g = 0.3193
P0 (1 fc )
Page | 13

MARR= ie =
ce
ke = 31.93%
cc
The case when the financing source is unknown, we use k (WACC) as MARR,
MARR= k
k = id
cd
ce
+ ie
cd + ce
cd + ce
cs
ks (1 t m ) , interest rate of term loan after tax = 10%.
cd
c
ie = c ke = 0.3193% from the first case
ce
id =
Games Inc. intends to maintain its current debt to equity ratio when financing
to purchase new equipment. Therefore, they will be financing the cost of new
equipment, $10M, the amount of $4M from debt of long term debt and $6M
from equity of stock.
Therefore,
cc = ce = $6M, cs = cd = $4M
MARR = k = id
cd
ce
+ ie
= 21.56%
cd + ce
cd + ce
(d)
The current stock price*(shares outstanding) = $18(1M)
PW of increasing profit after installing and operating the new machine =
$6,534K
The number of shares to be sold to net $6,000K
= $6,000K / {(1-fc)*stock price per share} = 374,532 shares
The most likely estimate for Games stock price
= {the current total stock price + increasing profit after installing and
operating the new machine}/ total shares outstanding
= {18M +6,534K }/ (1,000,000+374,532)shares
= $17.85
Finally, the most likely estimate for Games stock price may be $ $17.85.
Page | 14

Note) The income statement and cash flows of most likely case are like below:
Income statement
Inflation
Revenue
Expense
Depreciation
Debt Interest rate
1
$48,400
$38,720
$1,445
$400
$7,835
$3,134
$4,701
(1000US$)
2
$53,240
$31,944
$1,234
$400
$19,662
$7,865
$11,797
(1000US$)
2
10%
10%
Taxable income
Income taxes(40%)
Net income
Cash flow statement

Operating activities
Net income
Depreciation
$4,701
$1,445
$11,797
$1,234
Investment activities
Investment
Salvage
Gains tax
financing activities
Borrowed funds
Principal repayment
Common stock
Cash dividend
Net cash flow(Actual $)
PW=
-$10,000
$5,929
-$557
10%
$4,000
$6,000
$0
-$796
$5,350
-$4,000
-$6,742
-$880
$6,782
$6,534
Depreciation base:
Equipment: $10,000,000
Installation expense: (20 employees)(40 hours per week)(2 weeks)($50 per
hour) = $80,000
Depreciation base :$10,080,000 (in todays dollars)
D1: $10, 80,000 (0.1429) = $1,440,432; D2: $10,800,000(0.2449) =
$2,468,592. With the half-year convention, D2 = $1,234,296
Salvage value calculation:
Market value of the equipment decreases at an annual rate of 30%.
Therefore, the salvage value at the end of year 2 would be $10,000,000(1
0.70)2 = $4,900,000 (in todays dollars). The market value (inflated) two
years from now would be $5,929,000.
(e) Not provided
Page | 15

ST 15.2
(a) There are 40 alternatives including the do-nothing alternative.
Alternative
(j)
Projects
Selected
Firstyear
Expenditure
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
0
1
2
4
5
6
7
(1,4)
(1,7)
(2,4)
(2,7)
(1,6)
(2,6)
(2,5)
(2,3)
(1,5)
(1,4,7)
(1,4,6)
(1,4,5)
(1,7,6)
(1,7,5)
(2,4,6)
(2,4,5)
(2,4,7)
(2,7,6)
(2,7,5)
(2,3,4)
(2,3,7)
(2,3,6)
(2,3,5)
(1,4,7,6)
(1,4,7,5)
(2,4,7,6)
(2,4,7,5)
(2,3,4,6)
(2,3,4,5)
(2,3,7,6)
(2,3,7,5)
(2,3,4,6,7)
(2,3,4,5,7)
300,000
100,000
50,000
50,000
50,000
70,000
350,000
370,000
150,000
170,000
500,000
300,000
150,000
100,000
350,000
420,000
550,000
400,000
570,000
420,000
350,000
200,000
220,000
370,000
170,000
150,000
170,000
300,000
150,000
620,000
470,000
420,000
270,000
350,000
200,000
370,000
220,000
420,000
270,000
Secondyear
Expenditure
300,000
100,000
300,000
300,000
10,000
100,000
10,000
400,000
310,000
300,000
600,000
500,000
300,000
110,000
100,000
400,000
10,000
310,000
400,000
700,000
410,000
310,000
310,000
600,000
510,000
500,000
800,000
110,000
410,000
410,000
710,000
600,000
900,000
510,000
810,000
610,000
910,000
Engineering
Hours
4,000
7,000
6,000
3,000
3,000
10,000
4,000
13,000
7,000
4,600
7,600
10,000
9,000
7,000
10,000
10,600
13,000
4,600
7,000
13,600
16,000
13,000
7,600
7,000
15,000
9,000
9,600
12,000
10,600
13,000
13,600
16,000
15,600
18,000
9,600
12,000
15,600
18,000
Page | 16

(b) Only 17 alternatives are feasible as shown in part (a).

(c) Without knowing the exact cash flow sequence for each project over the
project life, it is not feasible to determine the optimal capital budget.
ST 15.3
(a) Select A and C with FW(10%) = $4,894. Since there are $500 left over after
selecting A and C, this left-over is lent out at 10% for 3 periods. Therefore, the
total amount available for lending at the end of period 3 is calculated as
follows:
F = $4,894 + $500( F / P,10%,3)
= $5,559.60
(b) Select B and C. The total amount available for lending at the end of period 3 is
$5,740.
(c) With a budget limit of $3,500, the reasonable MARR should be the lending
rate of 10%. (You select A and C and have $500 available for lending.)
ST 15.4
(a) The debt repayment schedule for the loan from the equipment manufacturer:
n
Loan Repayment
Interest
Principal
Loan Balance
$2,000,000
$200,000
$125,491
$1,874,509
$187,451
$138,040
$1,736,469
$173,647
$151,844
$1,584,625
$158,463
$167,028
$1,417,597
$141,760
$183,731
$1,233,866
$123,387
$202,104
$1,031,762
$103,176
$222,315
$809,447
$80,945
$244,546
$564,901
$56,490
$269,001
$295,901
10
$29,590
$295,901
$0
Page | 17

(b) The flotation costs and the number of common stocks to raise $8,500,000:
$8,500, 000
flotation cost =
$8,500, 000 = $749,184
1 0.081
$8,500, 000
= 205,537 shares
number of shares =
(1 0.081)($45)
(c) The flotation costs and the number of $1,000 bonds to raise $10.5 million:
$10,500, 000
$10,500, 000 = $203,364
1 0.019
$10,500, 000
= 11,893units
number of bonds =
(1 0.019)($900)
flotation cost =
Page | 18

ST 15.5
Income Statement
Revenue
Electricity Bill
Excess power
Expenses
O&M
Misc.
Standby power
Overhead
Overhaul
Depreciation
Unit
Inter Equipment
Interest (9%)
(a) The net cash flow the cogeneration project with bond financing
0
10
11
12
$6,120,000
$480,000
$6,120,000
$480,000
$6,120,000
$480,000
$6,120,000
$480,000
$6,120,000
$480,000
$6,120,000
$480,000
$6,120,000
$480,000
$6,120,000
$480,000
$6,120,000
$480,000
$6,120,000
$480,000
$6,120,000
$480,000
$6,120,000
$480,000
$500,000
$1,000,000
$6,400
$1,280,000
$500,000
$1,000,000
$6,400
$1,280,000
$500,000
$1,000,000
$6,400
$1,280,000
$1,500,000
$500,000
$1,000,000
$6,400
$1,280,000
$500,000
$1,000,000
$6,400
$1,280,000
$500,000
$1,000,000
$6,400
$1,280,000
$1,500,000
$500,000
$1,000,000
$6,400
$1,280,000
$500,000
$1,000,000
$6,400
$1,280,000
$500,000
$1,000,000
$6,400
$1,280,000
$1,500,000
$500,000
$1,000,000
$6,400
$1,280,000
$500,000
$1,000,000
$6,400
$1,280,000
$500,000
$1,000,000
$6,400
$1,280,000
$500,000
$100,000
$1,070,370
$950,000
$160,000
$1,070,370
$855,000
$96,000
$1,070,370
$770,000
$57,600
$1,070,370
$693,000
$57,600
$1,070,370
$623,000
$28,800
$1,070,370
$590,500
$0
$0
$0
$0
$0
$1,070,370
$1,070,370
$1,070,370
$1,070,370
$1,070,370
$1,070,370
Taxable Income
$2,143,230
$1,633,230
$292,230
$1,915,630
$1,992,630
$591,430
$2,152,730
$2,743,230
$1,243,230
$2,743,230
$2,743,230
$2,743,230
Net Income
$1,371,667
$1,045,267
$187,027
$1,226,003
$1,275,283
$378,515
$1,377,747
$1,755,667
$795,667
$1,755,667
$1,755,667
$1,755,667
$1,371,667
$1,045,267
$187,027
$1,226,003
$1,275,283
$378,515
$1,377,747
$1,755,667
$795,667
$1,755,667
$1,755,667
$1,755,667
$500,000
$100,000
$950,000
$160,000
$855,000
$96,000
$770,000
$57,600
$693,000
$57,600
$623,000
$28,800
$590,500
$590,501
$590,502
$590,503
$590,504
$295,000
Cash Flow Statement

Cash from operation
Net Income
Depreciation
Unit
Inter Equipment
Investment/Salvage
Unit
Inter Equipment
Gains Tax
Loan Repayment
Net cash flow
PW(27%) =
($10,000,000)
($500,000)
$1,000,000
$490,136
($11,893,000)
$10,500,000
$0
$1,971,667
$2,155,267
$1,138,027
$2,053,603
$2,025,883
$1,030,315
$1,968,247
$2,346,168
$1,386,169
$2,346,170
$2,346,171
($8,352,196)
$5,879,590
Page | 19

(b) The maximum annual lease amount that ACC is willing to pay is $1,183,771. (By Excel Goal Seek)
Income Statement
Revenue
Electricity Bill
Excess power
Expenses
O&M
Misc.
Standby power
Overhead
Lease
10
11
12
$6,120,000
$480,000
$6,120,000
$480,000
$6,120,000
$480,000
$6,120,000
$480,000
$6,120,000
$480,000
$6,120,000 $6,120,000
$480,000 $480,000
$6,120,000
$480,000
$6,120,000
$480,000
$6,120,000
$480,000
$6,120,000
$480,000
$6,120,000
$480,000
$500,000
$1,000,000
$6,400
$1,280,000
$1,183,771
$500,000
$1,000,000
$6,400
$1,280,000
$1,183,771
$500,000
$1,000,000
$6,400
$1,280,000
$1,183,771
$500,000
$1,000,000
$6,400
$1,280,000
$1,183,771
$500,000
$1,000,000
$6,400
$1,280,000
$1,183,771
$500,000 $500,000
$1,000,000 $1,000,000
$6,400
$6,400
$1,280,000 $1,280,000
$1,183,771 $1,183,771
$500,000
$1,000,000
$6,400
$1,280,000
$1,183,771
$500,000
$1,000,000
$6,400
$1,280,000
$1,183,771
$500,000
$1,000,000
$6,400
$1,280,000
$1,183,771
$500,000
$1,000,000
$6,400
$1,280,000
$1,183,771
$500,000
$1,000,000
$6,400
$1,280,000
$1,183,771
Taxable Income
Income Taxes (36%)
$2,629,829
$946,738
$2,629,829
$946,738
$2,629,829
$946,738
$2,629,829
$946,738
$2,629,829
$946,738
$2,629,829 $2,629,829
$946,738 $946,738
$2,629,829
$946,738
$2,629,829
$946,738
$2,629,829
$946,738
$2,629,829
$946,738
$2,629,829
$946,738
Net Income
$1,683,090
$1,683,090
$1,683,090
$1,683,090
$1,683,090
$1,683,090 $1,683,090
$1,683,090
$1,683,090
$1,683,090
$1,683,090
$1,683,090
Cash from operation

Net Income
$1,683,090
$1,683,090
$1,683,090
$1,683,090
$1,683,090
$1,683,090 $1,683,090
$1,683,090
$1,683,090
$1,683,090
$1,683,090
$1,683,090
$1,683,090
$1,683,090
$1,683,090
$1,683,090
$1,683,090
$1,683,090 $1,683,090
$1,683,090
$1,683,090
$1,683,090
$1,683,090
$1,683,090
Net cash flow

PW(27%) =
$0
$5,879,590
Page | 20

In case of an operating lease, the lesser is responsible for maintaining the equipment in good condition during the lease period,
so we may assume that the lesser would be responsible for bearing the overhaul costs.
Page | 21

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Contemporary Engineering Economics, Fifth Edition, by Chan S. Park.

Chapter 15 Capital-Budgeting Decision

25 X 1.5 X = $10, 000, 000

$10, 000, 000

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

(b) Equal repayment of the interest:

(c) Equal annual installment:

A = $500, 000( A / P,9%, 6) = $111, 460

(a) Equity Financing

$100,000 $100,000 $100,000 $100,000

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

Cash Flow Statement

Net cash flow

(b) Debt Financing

Cash Flow Statement

Income Statement (Bank B)

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

Cash Flow Statement

Net cash flow

(c) Best course of action: Adopt Bank Bs repayment plan

= $29, 250, 000

(b) Number of shares or (bonds) to be sold to raise $65 million:

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

(c) Cash requirement to meet financing costs:

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

Now to raise $10 million, The Sweeny would have to sell

15.7 Cost of retaining earnings:

(b) Cost of new common stock:

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

k = (0.076)(0.30) + (0.132)(0.70) = 0.1152

$90,000 $90,000 $90,000

$41,820 $22,931 $38,624 $50,519 $68,692

$26,765 $14,676 $24,719 $32,332 $43,963

Cash Flow Statement

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

(b) Cost of capital method:

$90,000 $90,000 $90,000 $90,000 $90,000

$51,420 $31,020 $45,020 $55,020 $71,070

$32,909 $19,853 $28,813 $35,213 $45,485

Cash Flow Statement

$32,909 $19,853 $28,813 $35,213 $45,485

Net cash flow

$19,670 $29,115 $36,905

$13,769 $20,381 $25,834

Cash Flow Statement

$11,200 $3,734 $13,769 $20,381 $25,834

Net cash flow

($40,000) $22,301 $25,501 $21,200 $18,366 $40,485

The project is acceptable.

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

(b) Cost of capital method:

$25,000 $13,000 $25,800 $33,480 $39,240

$9,100 $18,060 $23,436 $27,468

Cash Flow Statement

$17,500 $9,100 $18,060 $23,436 $27,468

Net cash flow

($100,000) $37,500 $41,100 $37,260 $34,956 $57,684

The project also is acceptable.

Cash Flow Statement

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

$10,060 $10,371 $14,168

Cash Flow Statement

Machine B should be better.