PROBLEM 2-10

Given Solution Legend

Cost of Tester (Year 0) $ 250,000 = Value given in problem
Installation and training costs $ 10,000 = Formula/Calculation/Analysis required
CAPEX (Year 5) $ 100,000 = Qualitative analysis or Short answer required
Annual cost savings $ 70,000 = Goal Seek or Solver cell
Salvage value $ 5,000 = Crystal Ball Input
Depreciation Straight Line = Crystal Ball Output
Project Life 10 years
Tax rate 30%
Cost of Capital 12%

Solution
a. Year
0 1 2 3 4 5 6 7
Investment Outlays
Equipment purchases $ (250,000) $ (100,000)
Installation costs (10,000)
Initial Outlay $ (260,000)
After-tax salvage value
Free Cash Flows
Operating Expense Savings $ 70,000 $ 70,000 $ 70,000 $ 70,000 $ 70,000 $ 70,000 $ 70,000
Less: Depreciation Expense (26,000) (26,000) (26,000) (26,000) (26,000) (46,000) (46,000)
Additional Operating Income $ 44,000 $ 44,000 $ 44,000 $ 44,000 $ 44,000 $ 24,000 $ 24,000
Less: Taxes (13,200) (13,200) (13,200) (13,200) (13,200) (7,200) (7,200)
NOPAT $ 30,800 $ 30,800 $ 30,800 $ 30,800 $ 30,800 $ 16,800 $ 16,800
Plus: Depreciation 26,000 26,000 26,000 26,000 26,000 46,000 46,000
Less: CAPEX (260,000) - - - - (100,000) - -
Free Cash Flow $ (260,000) $ 56,800 $ 56,800 $ 56,800 $ 56,800 $ (43,200) $ 62,800 $ 62,800

b.
Net Present Value $ 17,590
Internal Rate of Return 13.61%

NPV Profile
Discount Rates $ 17,590
0% 241,500 $ 241,500
2% 188,124 $ 188,124
4% 142,825 $ 142,825
6% 104,168 $ 104,168
8% 71,000 $ 71,000
10% 42,391 $ 42,391
12% 17,590 $ 17,590
14% (4,019) $ (4,019)
16% (22,937) $ (22,937)
18% (39,577) $ (39,577)
20% (54,279) $ (54,279)
22% (67,327) $ (67,327)
24% (78,955) $ (78,955)
26% (89,362) $ (89,362)
28% (98,711) $ (98,711)
30% (107,144) $ (107,144)
32% (114,777) $ (114,777)
34% (121,710) $ (121,710)
36% (128,030) $ (128,030)
38% (133,810) $ (133,810)
40% (139,111) $ (139,111)
 8 9 10

3,500

$ 70,000 $ 70,000 $ 70,000

(46,000) (46,000) (46,000)
$ 24,000 $ 24,000 $ 24,000
(7,200) (7,200) (7,200)
$ 16,800 $ 16,800 $ 16,800
46,000 46,000 46,000
- - -
$ 62,800 $ 62,800 $ 66,300
 PROBLEM 2-11

Given
Investment $ (4,000,000)
Plant life 5
Salvage value $ 400,000 248000
Variable Cost % 45% This is the solution to part a. of the problem. To
Fixed operating cost $ 1,000,000 solve for part b. simply type in 55% in place of
Tax rate 38% 45% for the variable cost %.
Working capital 10% Change in revenues
Required Rate of Return 15%

Solution
Year
0 1 2 3 4 5
Sales volume $ 1,000,000 $ 1,500,000 $ 3,000,000 $ 3,500,000 $ 2,000,000
Unit Price 2.00 2.00 2.50 2.50 2.50

Revenues 2,000,000 3,000,000 7,500,000 8,750,000 5,000,000

Variable Operating Costs (900,000) (1,350,000) (3,375,000) (3,937,500) (2,250,000)
Fixed Operating Costs (1,000,000) (1,000,000) (1,000,000) (1,000,000) (1,000,000)
Depreciation Expense (800,000) (800,000) (800,000) (800,000) (800,000)
Net Operating Income $ (700,000) $ (150,000) $ 2,325,000 $ 3,012,500 $ 950,000
Less: Taxes 266,000 57,000 (883,500) (1,144,750) (361,000)
NOPAT $ (434,000) $ (93,000) $ 1,441,500 $ 1,867,750 $ 589,000
Plus: Depreciation 800,000 800,000 800,000 800,000 800,000
Less: CAPEX (4,000,000) - - - - 248,000
Less: Working Capital (200,000) (100,000) (450,000) (125,000) 375,000 500,000
Free Cash Flow $ (4,200,000) $ 266,000 $ 257,000 $ 2,116,500 $ 3,042,750 $ 2,137,000

NPV $ 419,435
IRR 18%
 Solution Legend
= Value given in problem
= Formula/Calculation/Analysis required
= Qualitative analysis or Short answer required
= Goal Seek or Solver cell
= Crystal Ball Input
= Crystal Ball Output