Question 1) Oak Enterprises accepts projects earning more than the firm's 15% cost of capital. Oak is currently considering a 10-year project that provides annual cash inflows of $10,000 and requires an initial investment of $61,450. (Note: All amounts are after taxes.)
a. Determine the IRR of this project. Is it acceptable?
b. Assuming that the cash inflows continue to be $10,000 per year; how many additional years would the flows have to continue to make the project acceptable (that is, to make it have an IRR of 15%)?
c. With the given life, initial investment, and cost of capital, what is the minimum annual cash inflow that the firm should accept?
Question 2) Strong Tool Company has been considering purchasing a new lathe as a replacement for a fully depreciated lathe that can last 5 more years. The new lathe is expected to have a 5-year life and depreciation charges of $2,000 in year 1; $3,200 in year 2; $1,900 in year 3; $1,200 in both year 4 and year 5; and $500 in year 6. The firm estimates the revenues and expenses (excluding depreciation and interest) for the new and the old lathes to be as shown in the following table. The firm is subject to a 40% tax rate. Should the new lathe be purchased? The price of the new lathe is $ 10,000 and the cost of capital is 10 annually.
Year New lathe Old lathe
Revenue Expenses (excl. depr. and int.) Revenue Expenses (excl. depr. and int.)
1 $40,000 $30,000 $35,000 $25,000
2 $41,000 $30,000 $35,000 $25,000
3 $42,000 $30,000 $35,000 $25,000
4 $43,000 $30,000 $35,000 $25,000
5 $44,000 $30,000 $35,000 $25,000
1) Calculate the operating cash inflows associated with each lathe. (Note: Be sure to consider the depreciation in year 6).
2) Calculate the incremental (relevant) operating cash inflows resulting from the proposed lathe replacement.
3) Depict on a time line the incremental operating cash inflows caluculated in part B.