Question 1 - A firm believes it can generate an additional $260,000 per year in revenues for the next 5 years if it replaces existing equipment that is no longer usable with new equipment that costs $280,000. The firm expects to be able to sell the new equipment when it is finished using it (after 5 years) for $20,000. The existing equipment has a book value of $35,000 and a market value of $25,000. Variable costs are expected to total 70% of revenue. The additional sales will require an initial investment in net working capital of $26,000, which is expected to be recovered at the end of the project (after 5 years). Assume the firm uses straight line depreciation, its marginal tax rate is 35%, and its weighted-average cost of capital is 10%.
a) How much value will this new equipment create for the firm?
b) At what discount rate will this project break even?
c) Should the firm purchase the new equipment? Be sure to justify your recommendation.
Question 2 - Your company is interested in having a new facility constructed. The contractor expects that it will take approximately 3 years to complete the building. The contractor has offered you three payment plans for the building. They are as follows:
Time Plan 1 Plan 2 Plan 3
Today $300,000 $1,035,000 $950,000
1 year from now $1,300,000 $1,035,000 $0
2 years from now $1,300,000 $1,035,000 $1,600,000
3 years from now $1,300,000 $1,035,000 $1,600,000
The CFO of your company has asked you to provide recommendation concerning which payment plan to accept. What is your recommendation? Assume your weighted-average cost of capital is 10%.