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Chapter 10

Chapter 10. Capital Budgeting.

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Chapter 10

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  1. Chapter 10 Capital Budgeting

  2. Pearl’s Parkade Ltd is analyzing the replacement of its existing ticketing procedure to reduce parkade labour costs. The new machine would cost $100,000. It would cause labour costs to fall by $30,000 per year for its fifteen year expected useful life. Salvage value is estimated at $5,000. CCA is charged at 10%. The firm’s cost of capital is 12% and its corporate tax rate is 40%. Should Pearl buy the machine or continue using manual labour? • Answer: -$20,749 - Reject

  3. Alki Dyes has just obtained a new filtration tank at a cost of $18,000. The estimated liquidation value of the new tank, at the end of its three year useful life, is $1,000. The CCA rate is 50%. Estimated pre-tax cash flows before depreciation and taxes are estimated as follows: Year 1 $10,000 Year 2 $10,000 Year 3 $10,000 It is estimated that NWC will rise by $4,000 at the start of the project but this will be recovered when the project ends in three years. The corporate tax rate is 40% and the cost of capital is 14%. What is the project’s NPV? Answer: +$373

  4. Randy-White Trucking is analyzing a replacement issue for its current fleet of trucks. Two options are under consideration: Option A: Purchase new Kenworths at a cost of $250,000 per new tractor. The tractors have a useful life of 10 years and an estimated salvage value of $50,000 at that time. The dealer will offer $15,000 as a trade-in value on the firm’s existing trucks Option B: Purchase new Western Star trucks at a cost of $150,000 per new tractor. These trucks are expected to last for 6 years, at which time they could be sold for $30,000. At the end of year 6, a new Western Star truck will be purchase at a cost of $150,000. It will have a salvage value of $50,000 at the end of year 4. No trade-in value will be given for the firm’s existing trucks. The firm’s tax rate is 25% and their cost of capital is 18%. Trucks are a class 10 asset with a 30% CCA rate. Which option should the firm choose & why. Answer: Option A - $193,021 Option B - $158,458

  5. RM Glassworks has annual cash revenues of $400,000, annual cash expenses of 200,000 and annual depreciation expense of $60,000. These are expected to remain constant, as long as RM continues to have an outside firm do its packaging. However, if a new packaging machine is purchased at a cost of $100,000, RM will be able to reduce delivery time, thereby increasing sales to time sensitive customers. The packaging machine has a life of 20 years, an expected salvage value of $10,000 and a CCA rate of 10%. The new machine is expected to increase the firm’s annual cash revenues to $500,000 with annual cash expenses of $260,000. Due to the increase in sales, NWC is expected to rise by $50,000 initially but this will be recovered at the end of the 20 year period. Given a corporate tax rate of 40% and a 12% cost of capital, should RM purchase the new machine? Answer: $52,504

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