Question

Your uncle is a proud owner of an up-market clothing store. Because business is down he is
considering replacing the languishing tie department (20 sq mtr) with a new sportswear department. In order
to examine the profitability of such move he hired a financial advisor to estimate the cash flows
of the new department.The financial advisor came up with the following calculation
The financial advisor's calculation
Discount rate 12%
Rearranging the shop -40,000
Loss of business during renovation -15,000
Payment to the financial advisor -12,000
Total -67,000 #VALUE!

Annual earnings from the sport department 75,000

Loss of earnings from the tie department -35,000
Additional worker for the sports department -18,000
Municipality Tax (20sq m* $750per sq m) -15,000
Total 7,000 #VALUE!
NPV -8,667 #VALUE!

Your surprised uncle asked you (a promising finance student) to go over the calculation. What
are the correct NPV and IRR of introducing the new sportwear dept in palce tie department?

Answer
ment. In order
Question
You are the owner of a factory that supplies chairs and tables to schools in Denver.
You are currently operating at 80% of your capacity . You sell
each chair for $1.76 and each table for $4.40 based on the following calculation:
Chair department Table department
No. of units 100,000 20,000
Cost of material $80,000.00 $35,000.00
Cost of Labor $40,000.00 $20,000.00
Fixed Cost $40,000.00 $25,000.00
Total cost $160,000.00 $80,000.00
Minimum price per unit $2.00 $2.29

You have received an offer from a school in Colorado Springs to supply an additional 10,000
chairs and 2,000 tables for the price of $1.5 and $3.5 respectively. Your financial advisor
advises you not to take up the offer because the price does not even cover the cost of production.
Is the financial advisor correct?

Answer
Question
A factory is considering the purchase of a new machine for one of its units. The machine costs
$100,000. The machine will be depreciated on a straight line basis over its 10-year life to a
salvage value of zero. The machine is expected to save the company $50,000 annually, but in
order to operate it the factory will have to transfer an employee (with a salary of $40,000 a year)
from one of its other units. A new employee (with a salary of $20,000 a year) will be required to
replace the transferred employee. What is the NPV of the purchase of the new machine if the
relevant discount rate is 8% and corporate tax rate is 35%?
Answer

Discount rate 8%
Corporate tax 35%
Machine's life span 10

Investment

Annual saving
Cost of new worker
Depreciation
Taxes #VALUE!
Net income #VALUE!
Add back depreciation
Annual cash flow #VALUE!

Year Cash Flow

0 #VALUE!
1
2 #VALUE!
3
4
5
6
7
8
9
10

NPV #VALUE!
Question
A company is considering buying a new machine for one of its factories. The cost of the
machine is $60,000 and its expected life span is five years. The machine will save the cost of a
worker estimated at $22,500 annually. The book value of the machine at the end of year 5 is
$10,000 but the company estimates that the market value will be only $5,000. Calculate the
NPV of the machine if the discount rate is 12% and the tax rate is 30%. Assume straight-line
depreciation over the five-year life of the machine
Answer
Machine cost
Machine book value, year 5
Annual depreciation #VALUE!
Annual cost savings, before tax

Salvage value, year 5

Cash flow from salvage #VALUE!

Tax rate 30%

Discount rate 12%

Year Cash flow

0
1
2
3
4
5

- #VALUE!
Question
The ABD Company is considering buying a new machine for one of its factories. The
machine cost is $100,000 and its expected life span is 8 years. The machine is expected to reduce
the production cost by $15,000 annually. The terminal value of the machine is $20,000 but the
company believes that it would manage to sell it for $25,000. If the appropriate discount
rate is 15% and the corporate tax is 40%:
a. Calculate the project NPV.
b. Calculate the project IRR.
Answer
Discount rate 12%
Corporate tax 40%
Machine cost 100,000
Machine's terminal value 20,000
Machine's life span 8
Annual depreciation 10,000 #VALUE!

Annual Calculations

Earnings before depreciation and taxes

Depreciation #VALUE!
Earnings pre tax #VALUE!
Taxes #VALUE!
Net profit #VALUE!
FCF #VALUE!

Calculation of NPV for the 8 years

0
1 #VALUE!
2
3
4
5
6
7 #VALUE!
8
8 (sale of the machine) #VALUE!

NPV #VALUE!
Question
The "Car Clean" company operates a car wash business. The company bought a machine 2
years ago at the price of $60,000. The life span of the machine is 6 years and the machine has no
disposal value, the current market value of the machine is $20,000. The company is considering
buying a new machine. The cost of the new machine is $100,000 and its life span is 4 years. The
new machine has a disposal value of $20,000. The new machine is faster then the old one; thus
the company believes the revenue will increase from $1 million annually to $1.03 million. In
addition the new machine is expected to save the company $10,000 in water and electricity costs.
The discount rate of "Car Clean" is 15% and the corporate tax rate is 40%. What is the NPV of
replacing the old machine?
Answer
Discount rate 15%
Corporate tax 40%
Old Machine
Machine cost 60,000
Machine's terminal value 0
Machine's life span 6
Annual depreciation 10,000 #VALUE!
Book value (at t=0) 40,000 #VALUE!
Market Value (at t=0) 20,000
New machine
Machine cost 100,000
Machine's terminal Value 20,000
Machine's life span 4
Annual depreciation 20,000 #VALUE!
0 1 2 3 4
Investment
sale of the old machine #VALUE!
Revenue increase
Annual cost save
Earnings before depreciation & taxes #VALUE!
Tax #VALUE!
Net profit #VALUE!
Depreciation tax shield (new machine) #VALUE!
Lost of depreciation (old machine) #VALUE!
FCF #VALUE!

NPV

-72000 28000 28000 28000 28000

7939.394
Question
A company is considering whether to buy a regular or color photocopier for the office. The
cost of the regular machine is $10,000, its life span is 5 years and the company has to pay
another $1,500 annually in maintenance costs. The color photocopiers price is $30,000, its life
span is also 5 years and the annual maintenance costs are $4,500. The color photocopier is
expected to increase the revenue of the office by $8,500 annually. Assume that the company is
profitable and pays 40% corporate tax, the relevant interest rate is 11%. Which photocopy
machine should the firm buy?
Answer
Discount rate 11%
Corporate tax 40%
Regular photocopy
Machine cost 10,000
Life span 5
Annual costs 1,500
Annual depreciation 2,000 #VALUE!
Color photocopy
Machine cost 30,000
Life span 5
Annual costs 4,500
Annual depreciation 6,000 #VALUE!
Additional turn over 8,500

Calculating the differential cash flows (color-regular)

0 1 2 3 4 5
Differential investment
Additional turn over
Differential annual costs
Earnings before depreciation & taxes
Differential depreciation
Earning before tax
Tax
Net Profit
FCF

NPV

-20000 4900 4900 4900 4900 4900

-1890.105
#VALUE!

#VALUE!

#VALUE!

#VALUE!
Question
You bought a house in January 1996 for $100,000, and you sold the house at the end of 2002
for $185,000. The CPI rose in the period from 118 to 155.
a. What was your annualized nominal rate of return?
b. Calculate your annualized real rate of return?
Answer
Price of house Jan-96
Price of house Dec-02
CPI Jan-96
CPI Dec-02
Nominal rate of return 1996-2002 #VALUE!
Inflation rate 1996-2002 #VALUE!

Real rate of return 1996-2002 #VALUE!

Annual rate of return #VALUE!
5.014%
Question
The bank is offering you a new saving which will give you a 2% real annual interest rate. If
the inflation rate is 5% annually how long will it take you to double your money both in nominal
and real terms?
Answer
real interest rate
Annual inflation
Nominal interest rate
Nominal rates
t
Real rates
t
Question
A factory is considering purchasing a new machine. It has two alternatives:
Discount rate 8%
Tax rate 30%
Machine A Machine B
Cost 15,000 50,000
Other Annual costs (pre-tax) 4,286 1,429
Life span 3 7
If the company chooses one machine it will have to continue to choose the same machine
forever. Which machine should the company choose ?
Assume straight-line depreciation to zero salvage value over the life of each
machine.
Answer Machine A Machine B
Cost +depreciation
After tax EBIT
CF
Year
0
1
2
3
4
5
6
7
NPV Cost
PVIFA
EAC
-7,320.50 -8,460.76
Question
Your firm has to replace one of its fender-bender machines. One of your financial wizards
has determined that the appropriate discount rate for the machine cash flows is 10%. Your firm
has 2 alternatives:
a. Fender-bender machine A costs $400,000 and produces annual cash flows of $200,000
at the end of each of its 6 years of life.
b. Fender-bender machine B costs $200,000 but has only a 2 year life. However, it
produces a $300,000 annual cash flow at the end of each of these 2 years

Year cashflow(A cashflow(B)

0 -400 -200
1 200 300
2 200 300
3 200
4 200
5 200
6 200

Answer
NPV
PV
EAC
Question
You are the owner of a five year old taxi. Your doctor has advised you to quit driving due to
a health problem. You are considering two alternatives:
a. Selling the taxi for $15,000. Because the taxis book value is 0 you will have to pay
tax.
b. Renting your taxi to your cousin. Your cousin will pay you $4,000 at the beginning of
each year. You estimate that the taxi will be in working order for another 5 years and can
then be sold for $300.
Which is the more profitable alternative if your tax bracket is 25% and your discount rate
is 5%?
Answer
Question
Hunter Brothers Inc. needs to buy printers for its offices. It can buy an expensive laser
printers or much cheaper (but shorter-lived) inkjets. Here are some relevant facts:
A laser printer costs $1,000 and an inkjet costs $250.
A laser printer has an anticipated life of 6 years, but an inkjet has an anticipated life of
only 2 years. Printers are assumed to have a zero market value at the end of their lives.
The cost per page for a laser printer is $0.03, whereas the cost per page for an inkjet is
$0.10.
Each printer purchased is anticipated to print 10,000 pages per year
If Hunter Brothers has a discount rate of 12% and a tax rate of zero, which printers should it
buy? Assume that the whole years cost of printing falls at year end.
Answer
Choosing between Laser printers and Inkjets
Discount rate 12%
Corporate tax rate 0%
pages per year 10,000

Laser Inkjet
Printer cost $1,000.00 $250.00
Life span 6 2
Cost per page $0.03 $0.10
Printer's disposal Value - -
Laser 0 1 2 3 4 5 6
Investment
Printing cost per year
Total costs per year

NPV
PV
EAC

Inkjet 0 1 2
Investment
Printing cost per year
Total costs per year

NPV
PV
EAC

It's cheaper to use the laser printer