Reference no: EM132368680
Questions -
Question 1 - Consider the following cash flows on two mutually exclusive projects:
|
Year
|
Project A
|
Project B
|
|
0
|
-$50,000
|
-$65,000
|
|
1
|
30,000
|
29,000
|
|
2
|
25,000
|
38,000
|
|
3
|
20,000
|
41,000
|
The cash flows of project A are expressed in real terms, whereas those of project B are expressed in nominal terms. The appropriate nominal discount rate is 13 percent and the inflation rate is 4 percent. Which project should you choose?
Question 2 - Suppose we are thinking of replacing an old computer with a new one. The old one cost us $450,000; the new one will cost $580,000. The new machine will be depreciated straight-line to zero over its five-year life. It will probably be worth about $130,000 after 5 years.
The old computer is being depreciated at a rate of $90000 per year. It will be completely written off in three years. If we don't replace it now, we will have to replace it in two years. We can sell it now for $230,000; in two years it will probably be worth $60,000. The new machine will save us $85,000 per year in operating costs. The tax rate is 38 percent, and the discount rate is 14%.
a. Suppose we recognize that if we don't replace the computer now, we will be replacing it in two years. Should we replace it now or should we wait? (Hint: What we effectively have here is a decision either to "invest" in the old computer - by not selling it- or to invest in the new one. Notice that two investments have unequal lives).
b. Suppose we consider only whether we should replace the old computer now without worrying about what's going to happen in two years. What are the relevant cash flows? Should we replace it or not? (Hint: Consider the net change in the firm's after tax cash flows if we do the replacement).