MGMT 061 – evaluate the proposed acquisition of a new chromatograph for the firm’s

Subject: Business    / Finance
Question
QUESTION 1

The president of the company you work for has asked you to evaluate the proposed acquisition of a new chromatograph for the firm’s R&D department. The equipment’s basic price is $85,000, and it would cost another $20,000 to modify it for special use by your firm. The chromatograph, which falls into the MACRS 3-year class, would be sold after 3 years for $40,000. The MACRS rates for the first three years are 0.3333, 0.4445, and 0.1481. Use of the equipment would require an increase in net working capital (spare parts inventory) of $5,000. The machine would have no effect on revenues, but it is expected to save the firm $38,000 per year in before-tax operating costs, mainly labor. The firm’s marginal federal-plus-state tax rate is 40% and its cost of capital is 11%.

What is the year 1 operating cash flow?
$1,802
$7,447
$34,997
$36,799
$26,332

2 points

QUESTION 2

The Yoran Yacht Company (YYC), a prominent sailboat builder in Newport, may design a new 30-foot sailboat based on the “winged” keels first introduced on the 12-meter yachts that raced for the America’s Cup.

First, YYC would have to invest $5,000 at t = 0 for the design and model tank testing of the new boat. YYC’s managers believe there is a 70% probability that this phase will be successful and the project will continue. If Stage 1 is not successful, the project will be abandoned with zero salvage value.

The next stage, if undertaken, would consist of making the molds and producing two prototype boats. This would cost $400,000 at t = 1. If the boats test well, YYC would go into production. If they do not, the molds and prototypes could be sold for $100,000. The managers estimate the probability is 75% that the boats will pass testing and that Stage 3 will be undertaken.

Stage 3 consists of converting an unused production line to produce the new design. This would cost $1 million at t = 2. If the economy is strong at this point, the net value of sales would be $4 million; if the economy is weak, the net value would be $2.5 million. Both net values occur at t = 3, and each state of the economy has a probability of 0.5. YYC’s corporate cost of capital is 12%.

Assume this project has average risk. What is the NPV of the scenario that goes from the start and ends with YYC going through with the new sailboat and facing weak economy in the end?
($5,000)
$620,114
($185,952)
$1,095,000
$117,779

2 points

QUESTION 3

Shao Industries is considering a proposed project for its capital budget. The company estimates the project’s NPV is $12 million. This estimate assumes that the economy and market conditions will be average over the next few years. The company’s CFO, however, forecasts there is only a 50% chance that the economy will be average. Recognizing this uncertainty, she has also performed the following scenario analysis:
Economic Scenario    Probability of Outcome    NPV (millions)
Recession    0.1    ($60)
Below average    0.15    ($25)
Average    0.5    $15
Above average    0.2    $25
Boom    0.05    $32

What is the project’s standard deviation?

$3.00
$23.62
$4.35
$26.90
$55.80

2 points

QUESTION 4

The president of the company you work for has asked you to evaluate the proposed acquisition of a new chromatograph for the firm’s R&D department. The equipment’s basic price is $85,000, and it would cost another $20,000 to modify it for special use by your firm. The chromatograph, which falls into the MACRS 3-year class, would be sold after 3 years for $40,000. The MACRS rates for the first three years are 0.3333, 0.4445, and 0.1481. Use of the equipment would require an increase in net working capital (spare parts inventory) of $5,000. The machine would have no effect on revenues, but it is expected to save the firm $38,000 per year in before-tax operating costs, mainly labor. The firm’s marginal federal-plus-state tax rate is 40% and its cost of capital is 11%.

What is the last year’s total cash flow without including the operating cash flow?
$32,112
$7,447
$44,555
$61,132
$29,020

2 points

QUESTION 5

The Bartram-Pulley Company (BPC) must decide between two mutually exclusive investment projects. Each project costs $5,050 and has an expected life of 3 years. Annual net cash flows from each project begin 1 year after the initial investment is made and have the following probability distributions: BPC has decided to evaluate the riskier project at a 14% rate and the less risky project at a 8% rate. What is the coefficient of variation (CV) of project B?
Project A                Project B
Probability    Net Cash Flows        Probability    Net Cash Flows
0.2    $5,000            0.2    $3,000
0.6    7,750            0.6    9,750
0.2    8,500            0.2    18,000
1.2313
0.0703
0.4734
0.1647
0.7579

2 points

QUESTION 6

The president of the company you work for has asked you to evaluate the proposed acquisition of a new chromatograph for the firm’s R&D department. The equipment’s basic price is $85,000, and it would cost another $20,000 to modify it for special use by your firm. The chromatograph, which falls into the MACRS 3-year class, would be sold after 3 years for $40,000. The MACRS rates for the first three years are 0.3333, 0.4445, and 0.1481. Use of the equipment would require an increase in net working capital (spare parts inventory) of $5,000. The machine would have no effect on revenues, but it is expected to save the firm $38,000 per year in before-tax operating costs, mainly labor. The firm’s marginal federal-plus-state tax rate is 40% and its cost of capital is 11%.

What is the NPV of this project?
$29,400
$12,000
$1,359
($6,700)
$1,509

2 points

QUESTION 7

Although the Chen Company’s milling machine is old, it is still in relatively good working order and would last for another 5 years. It is inefficient compared to modern standards, though, and so the company is considering replacing it. The new milling machine, at a cost of $50,000 delivered and installed, would also last for 5 years and would produce after-tax cash flows (labor savings and depreciation tax savings) of $14,000 per year. It would have zero salvage value at the end of its life. The firm’s WACC is 11%, and its marginal tax rate is 35%. Should Chen buy the new machine?

$20,000
$1,540
$80,000
$1,743
$6,747

2 points

QUESTION 8

The president of the company you work for has asked you to evaluate the proposed acquisition of a new chromatograph for the firm’s R&D department. The equipment’s basic price is $85,000, and it would cost another $20,000 to modify it for special use by your firm. The chromatograph, which falls into the MACRS 3-year class, would be sold after 3 years for $40,000. The MACRS rates for the first three years are 0.3333, 0.4445, and 0.1481. Use of the equipment would require an increase in net working capital (spare parts inventory) of $5,000. The machine would have no effect on revenues, but it is expected to save the firm $38,000 per year in before-tax operating costs, mainly labor. The firm’s marginal federal-plus-state tax rate is 40% and its cost of capital is 11%.

What is the after-tax salvage value cash flow of the new machine at the end of project’s life?
$27,112
$20,519
$40,000
$30,000
$19,332

2 points

QUESTION 9

The Yoran Yacht Company (YYC), a prominent sailboat builder in Newport, may design a new 30-foot sailboat based on the “winged” keels first introduced on the 12-meter yachts that raced for the America’s Cup.

First, YYC would have to invest $5,000 at t = 0 for the design and model tank testing of the new boat. YYC’s managers believe there is a 70% probability that this phase will be successful and the project will continue. If Stage 1 is not successful, the project will be abandoned with zero salvage value.

The next stage, if undertaken, would consist of making the molds and producing two prototype boats. This would cost $400,000 at t = 1. If the boats test well, YYC would go into production. If they do not, the molds and prototypes could be sold for $100,000. The managers estimate the probability is 75% that the boats will pass testing and that Stage 3 will be undertaken.

Stage 3 consists of converting an unused production line to produce the new design. This would cost $1 million at t = 2. If the economy is strong at this point, the net value of sales would be $4 million; if the economy is weak, the net value would be $2.5 million. Both net values occur at t = 3, and each state of the economy has a probability of 0.5. YYC’s corporate cost of capital is 12%.

Assume this project has average risk. What is the joint probability of the scenario that goes from the start and ends with YYC going through with the new sailboat and facing strong economy in the end?
0.5000
0.2625
0.3000
0.2400
0.7500

2 points

QUESTION 10

The president of the company you work for has asked you to evaluate the proposed acquisition of a new chromatograph for the firm’s R&D department. The equipment’s basic price is $85,000, and it would cost another $20,000 to modify it for special use by your firm. The chromatograph, which falls into the MACRS 3-year class, would be sold after 3 years for $40,000. The MACRS rates for the first three years are 0.3333, 0.4445, and 0.1481. Use of the equipment would require an increase in net working capital (spare parts inventory) of $5,000. The machine would have no effect on revenues, but it is expected to save the firm $38,000 per year in before-tax operating costs, mainly labor. The firm’s marginal federal-plus-state tax rate is 40% and its cost of capital is 11%.

What is the Year-0 net cash flow?
($89,000)
($81,000)
($85,000)
($110,000)

($105,000)