1. Tutorial 7 Homework Solution
Net cash flows in Year
0: -$1,200,000 - $40,000 - $50,000 + $60,000 - ($90,400 - $60,000)(0.40) = -1,217,840
1: ($240,000)(0.60) + ($1,240,000)(0.3333)(0.40) = 309,317
2: ($240,000)(0.60) + ($1,240,000)(0.4445)(0.40) = 364,472
3: ($240,000)(0.60) + ($1,240,000)(0.1481)(0.40) = 217,458
4: ($240,000)(0.60) + ($1,240,000)(0.0741)(0.40) = 180,754
($300,000)(0.60) + $50, = 230,000

2. Initial CF
Cost ,200,000
Installation ,000
NWC inc ,000
Sale old asset ,000
Dep,n (90,400 – 60,000)(0.40) = +12,160
- 1,217,840

3. Operating CF
1: ($240,000)(0.60) + ($1,240,000)(0.3333)(0.40) = 309,317
2: ($240,000)(0.60) + ($1,240,000)(0.4445)(0.40) = 364,472
3: ($240,000)(0.60) + ($1,240,000)(0.1481)(0.40) = 217,458
4: ($240,000)(0.60) + ($1,240,000)(0.0741)(0.40) = 180,754
Terminal CF
Salvage value 300,000 x 0.6 = 180,000
NWC recovered = 50,000

4. Notes:
Salvage value is the amount the “new” asset can be sold for less tax because asset is fully written down for depreciation purposes
Depreciable value of the new asset is $1,240,000 (1,200, ,000)
Depreciation on old asset in its final year was $90,400, but the asset was worth just $60,000. Therefore there is a tax adjustment needed for the loss of $30,400 (i.e. 90,400 – 60,000)

5. Text book Ch 12, problem # 3 (p.320)
Period Rockbuilt Bulldog Savings Bulldog truck
0 ($74,000) ($59,000) ($15,000)
(2,000) (3,000) ,000
(2,000) (4,500) ,500
(2,000) (6,000) ,000
(2,000) (22,500) ,500
5 (13,000) (9,000) (4,000)
(4,000) (10,500) ,500
(4,000) (12,000) ,000
,000* (8,500)** ,500
* $4,000 maintenance cost plus salvage value of $9,000.
** $13,500 maintenance cost plus salvage value of $5,000.

6. Tutorial 8
4. The Cardinal Machine Tool Company is considering the purchase of a new drill press to replace the one currently being used.
The present machine should last another seven years and have no salvage value.
The current drill press has a book value of $700 and can be sold for $400.
Cardinal pays $300 a year maintenance on the press.
The new drill press will cost $1,500 and is expected to last seven years, at which time it will be sold for $100.
The maintenance cost of the new machine is expected to be $150 a year.
Cardinal depreciates its assets on the straight-line basis and pays 40% taxes.
If its opportunity cost of funds is 10%, should it buy the new machine?

7. Initial cost = $1,500 - $400 + ($700 - $400)(0.40) = $980
Annual savings after tax = ($300 - $150)(0.60) = $90
Change in depn = ($1,500 - $100)/7 - $700/7 = $100 per yr
Tax saving on depn change = ($100)(0.40) = $40
NPV at 10%:
= ($90 + $40)(4.868) + ($100)(0.513) - $980 = -$295.86
Since the NPV is negative, we would REJECT this project.

8. Text book Ch 13, problem # 8 (p.348)
Selecting those projects with the highest profitability index values would indicate the following:
Project Amount PI NPV*
$500, $110,000
, ,000
$850, $180,000
* NPV = (Amount x PI) - Amount
= (500,000 x 1.22) – 500,000 = 110,000

9. However, utilising “close to” full budgeting will be better.
Project Amount PI NPV
$500, $110,000
, ,000
$950, $191,000

10. b. No. The resort should accept all projects with a positive NPV
b. No. The resort should accept all projects with a positive NPV. If capital is not available to finance them at the discount rate used, a higher discount rate should be used, which more adequately reflects the costs of financing.