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Foundations of Finance

Tutorial 4 Questions

Question One

Two investment projects have been identified and the net cash flows for each appear below. The required rate of return is 10% p.a. for each. Calculate the NPV for each project and advise which project/s will increase the value of the host firm. If the projects were mutually exclusive, which project would you advise the host firm to choose?

	Year
Project	0	1	2	3	4	5
A	- 10000	3000	3000	3000	3000	3000
B	-21000	4000	4000	4000	8000	8000

Question Two

Sault Ltd is considering the acquisition of an ice cream machine compactor at a cost of $25,000. The machine is estimated to have zero value at the end of its five-year life. Depreciation is straight line and the company tax rate is 40%. The project will also return the following annual pre-tax net cash flows:

Year	Net Cash Flow ($)
1	6000
2	10000
3	12000
4	15000
5	7000

Given this information, and the fact that the project’s after-tax required rate of return is 10% p.a., calculate the project’s NPV. Should Sault Ltd accept the project? Why?

Question Three

Chaudhry Ltd is considering installing a new beer-making machine that costs $110,000 plus installation costs of $10,000. The new machine will generate cash revenues of $200,000 annually and has associated cash expenses of $125,000 per annum. The machine itself will be depreciated to a salvage value of $10,000 over a 10-year period using the straight-line depreciation method. At the end of the 10th year, the machine will then be sold for $15,000. Given the corporate tax rate is 30% p.a., determine the incremental cash flows associated with this project.

Question Four

The Templeton Manufacturing and Distribution Company of Fremantle, Western Australia, is contemplating the purchase of a new conveyor belt system for one of its regional distribution facilities. Both alternatives will accomplish the same task but the Eclipse Model is substantially more expensive than the Sabre Model and will not have to be replaced for 10 years, whereas the cheaper model will need to be replaced in just five years. The costs of purchasing the two systems and the costs of operating them annually over their expected lives are as follows:

Year	Eclipse	Sabre
0	(1 400 000)	(800 000)
1	(25 000)	(50 000)
2	(30 000)	(50 000)
3	(30 000)	(60 000)
4	(30 000)	(60 000)
5	(40 000)	(80 000)
6	(40 000)
7	(40 000)
8	(40 000)
9	(40 000)
10	(40 000)

(a) Templeton typically evaluates investments in plant improvements using a 12% required rate of return. What are the NPVs for the two systems?

(b) Calculate the equivalent annual costs for the two systems.

(c) Based on your analysis of the two systems using both their NPV and EAC, which system do you recommend the company pick? Why?

Question Five

Chocolate Heaven Ltd, producers of fine quality chocolates, need to replace a chocolate mixing machine. Two competing machines, A and B are available. Both machines are considered adequate in terms of their ability to complete the required tasks. Forecasted cash flows for each machine are provided below.

	A	B
Estimated life	3 years	6 years
Cost	13000	22000
Net Cash Inflows (pre tax)	10000	14000
Salvage Value	1000	4000
Depreciation (p.a.)	4000	3000

Given a tax rate of 40% and an after-tax required rate of return of 10% p.a., which machine would you recommend Chocolate Heaven should purchase? Why?