Problem Set 2

FIN 401: Financial Management Syed Waqar Ahmed

1

Problem Set 2

Problem 1 (5.0 Marks)

Based on the information provided below, decide the fate of the project using NPV analysis:

Project Information:

• Cost of equipment = $400,000

• Shipping & installation will be $20,000

• $25,000 in net working capital required at setup

• 3-year project life, 5-year class life

• Simplified straight line depreciation

• Revenues will increase by $220,000 per year

• Defects costs will fall by $10,000 per year

• Operating costs will rise by $30,000 per year

• Salvage value after year 3 is $200,000

• Cost of capital = 12%, marginal tax rate = 34%


2



Automation Project:

• Cost of equipment (shipped & Installed) = $575,000

• $15,000 in net working capital required at setup



• Current operating expenses are $640,000 per yr.

• New operating expenses will be $400,000 per yr.

• Already paid consultant $25,000 for analysis.

• Salvage value at the end of different years will follow the following schedule:

Years Salvage Value

1 $100,000

2 $75,000

3 $40,000

4 $30,000

5 $20,000



3



Replacement Project:

Old Asset (5 years old):

• Cost of equipment = $1,125,000



• Current salvage value is $400,000


New Asset:

• 5-year class life

• Cost of equipment = $1,750,000

• Shipping & installation will be $56,000


• $68,000 in net working capital required when setting up new Asset

• Will increase sales by $285,000 per year

• Operating expenses will fall by $100,000 per year

• Already paid $15,000 for training program

• Salvage value after year 5 is $500,000


Documents

Problem Set 2