Question 1. My firm is considering replacing old equipment with a new, more efficient model. The old equipment bought three years ago for $100,000, has a 5 - year MACRS life and can be sold for $50,000 or used for three more years when its resale value will be zero. The new equipment will cost $210,000, will have a three-year MACRS recovery period and will have a resale value of $20,000 after three years when the project will end. The new equipment will increase revenue before taxes by $25,000 and decrease costs before taxes by $50,000 per year. The firm’s tax rate is 40%, and the discount rate is 16%.
a) Calculate the depreciation for the old and new equipment for each year of their depreciable life.
b) Determine the net cash proceeds from the disposal of the old and new equipment.
c) Determine Cash Flows (Cfs) for the initial investment, operating life, and terminal point. Prepare a time line showing the CFs.
d) What is the NPV of this replacement?
e) What is the resale value of the new equipment that would make you indifferent about the project?
f) What is the discount rate that would make you indifferent about the project?
Question 2. My firm is considering the purchase of equipment to manufacture a new product for the foreseeable future. Type A has a life of five years and an NPV of $6,381. Type B has a life of seven years and an NPV of $9,426. Each of these different types of equipment will accomplish the same objective satisfactorily and would need to be replaced to continue production. Your firm’s required rate of return is 20%.
What is the equivalent annual annuity of each of these alternatives? Which alternative should be purchased? Explain the rational.
Question 3. Assume that the current rate of exchange is 0.85 EURO per one USD (US Dollar). If the current yearly nominal risk-free rate in the Eurozone is 6 percent per year , while it is 4.5% percent in the United States and the interest rate parity holds:
a) How many USD do you need today to buy EURO 1,000,000?
b) How many USD do you need one year from now on to buy one year forward EURO 1,000,000?
c) If the inflation in the EUROZONE is 3% and in the U.S. 2% what is the predicted exchange rate three years form now, assuming that each year you have the same inflation.