2024 – 1 After extensive medical and marketing research Pill Inc believes it can penetrate the pain reliever market It is

1. After extensive medical and marketing research, Pill, Inc., believes it can penetrate the pain reliever
market. It is considering two alternative products. The first is to produce a medication for headache pain. The second is a pill for headache and arthritis pain. Both products would be introduced at a price of $8.65 per package in real terms. The headache-only medication is projected to sell 3 million packages a year, while the headache and arthritis remedy would sell 4.3 million packages a year. Cash costs of production in the first year are expected to be $4.55 per package in real terms for the headache-only brand. Production costs are expected to be $5.10 in real terms for the headache and arthritis pill. All prices and costs are expected to rise at the general inflation rate of 3 percent.

Either product requires further investment. The headache-only pill could be produced using equipment costing $17 million. That equipment would last three years and have no resale value. The machinery required to produce the broader remedy would cost $28 million and last three years. The firm expects that equipment to have a $1 million resale value (in real terms) at the end of Year 3.

Pill, Inc., uses straight-line depreciation. The firm faces a corporate tax rate of 34 percent and believes that the appropriate real discount rate is 9 percent.

Calculate the NPV for the headache pain reliever only. (Enter your answer in dollars, not millions of dollars (e.g. 1,234,567). Do not round intermediate calculations and round your final answer to 2 decimal places (e.g., 32.16).)

NPV $
Calculate the NPV for the headache and arthritis pain reliever. (Enter your answer in dollars, not millions of dollars (e.g. 1,234,567). Do not round intermediate calculations and round your final answer to 2 decimal places (e.g., 32.16).)

NPV $

2. Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $3,150,000 and will last for six years. Variable costs are 35 percent of sales, and fixed costs are $285,000 per year. Machine B costs $5,382,000 and will last for nine years. Variable costs for this machine are 30 percent of sales and fixed costs are $220,000 per year. The sales for each machine will be $11.9 million per year. The required return is 10 percent, and the tax rate is 35 percent. Both machines will be depreciated on a straight-line basis. The company plans to replace the machine when it wears out on a perpetual basis.

Calculate the NPV for each machine. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places (e.g., 32.16).)

NPV
Machine A
Machine B

Calculate the EAC for each machine. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places (e.g., 32.16).)

EAC
Machine A
Machine B

Which machine should you choose?
Machine A
Machine B

3. J. Smythe, Inc., manufactures fine furniture. The company is deciding whether to introduce a new mahogany dining room table set. The set will sell for $7,900, including a set of eight chairs. The company feels that sales will be 2,350, 2,500, 3,050, 2,900, and 2,650 sets per year for the next five years, respectively. Variable costs will amount to 46 percent of sales, and fixed costs are $1.97 million per year. The new dining room table sets will require inventory amounting to 7 percent of sales, produced and stockpiled in the year prior to sales. It is believed that the addition of the new table will cause a loss of sales of 600 dining room table sets per year of the oak tables the company produces. These tables sell for $5,200 and have variable costs of 41 percent of sales. The inventory for this oak table is also 7 percent of sales. J. Smythe currently has excess production capacity. If the company buys the necessary equipment today, it will cost $20 million. However, the excess production capacity means the company can produce the new table without buying the new equipment. The company controller has said that the current excess capacity will end in two years with current production. This means that if the company uses the current excess capacity for the new table, it will be forced to spend the $20 million in two years to accommodate the increased sales of its current products. In five years, the new equipment will have a market value of $3.8 million if purchased today, and $8.3 million if purchased in two years. The equipment is depreciated on a seven-year MACRS schedule. The company has a tax rate of 40 percent, and the required return for the project is 14 percent. Table 8.3

Calculate the NPV of the new table. (Enter your answer in dollars, not millions of dollars (e.g., 1,234,567). Do not round intermediate calculations and round your final answer to 2 decimal places (e.g., 32.16).)

The table can be found at http://lectures.mhhe.com/connect/0077650441/Table_8.3.jpg

4.Price, Inc., is considering an investment of $385,000 in an asset with an economic life of 5 years. The firm estimates that the nominal annual cash revenues and expenses at the end of the first year will be $265,000 and $90,000, respectively. Both revenues and expenses will grow thereafter at the annual inflation rate of 3 percent. Price will use the straight-line method to depreciate its asset to zero over five years. The salvage value of the asset is estimated to be $65,000 in nominal terms at that time. The one-time net working capital investment of $20,000 is required immediately and will be recovered at the end of the project. All corporate cash flows are subject to a 34 percent tax rate.

What is the project’s total nominal cash flow from assets for each year? (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign.)

Cash flow
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5

5.Earp Brothers, Inc., is considering investing in a machine to produce computer keyboards. The price of the machine will be $987,000, and its economic life is five years. The machine will be fully depreciated by the straight-line method. The machine will produce 32,000 keyboards each year. The price of each keyboard will be $40 in the first year and will increase by 4 percent per year. The production cost per keyboard will be $15 in the first year and will increase by 5 percent per year. The project will have an annual fixed cost of $207,000 and require an immediate investment of $37,000 in net working capital. The corporate tax rate for the company is 34 percent. The appropriate discount rate is 10 percent.

What is the NPV of the investment? (Do not round intermediate calculations and round your answer to 2 decimal places (e.g., 32.16).)

NPV$

6.AGT Golf Academy is evaluating different golf practice equipment. The “Dimple-Max” equipment costs $95,000, has a 4-year life, and costs $8,700 per year to operate. The relevant discount rate is 13 percent. Assume that the straight-line depreciation method is used and that the equipment is fully depreciated to zero. Furthermore, assume the equipment has a salvage value of $18,500 at the end of the project’s life. The relevant tax rate is 35 percent. All cash flows occur at the end of the year. What is the equivalent annual cost (EAC) of this equipment? (A negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your final answer to 2 decimal places (e.g., 32.16).)

EAC$

7.Gold Star Industries is contemplating a purchase of computers. The firm has narrowed its choices to the SAL 5000and the HAL 1000. Gold Star would need six SALs, and each SAL costs $3,650 and requires $390 of maintenanceeach year. At the end of the computer’s eight-year life, Gold Star expects to sell each one for $190. Alternatively,Gold Star could buy five HALs. Each HAL costs $3,800 and requires $445 of maintenance every year. Each HALlasts for six years and has a resale value of $185 at the end of its economic life. Gold Star will continue to purchasethe model that it chooses today into perpetuity. Gold Star has tax rate of 35 percent. Assume that the maintenancecosts occur at year-end. Depreciation is straight-line to zero. What is the EAC of each model if the appropriatediscount rate is 11 percent? (A negative amount should be indicated by a minus sign. Do not roundintermediate calculations and round your final answer to 2 decimal places (e.g., 32.16).)

EAC
SAL 5000
HAL 1000

8.Compact fluorescent lamps (CFLs) have become more popular in recent years, but do they make financial sense?Suppose a typical 60-watt incandescent light bulb costs $.52 and lasts for 1,000 hours. A 15-watt CFL, whichprovides the same light, costs $3.75 and lasts for 12,000 hours. A kilowatt-hour is 1,000 watts for 1 hour. However,electricity costs actually vary quite a bit depending on location and user type. An industrial user in West Virginiamight pay $.04 per kilowatt-hour whereas a residential user in Hawaii might pay $.25.

You require a return of 11 percent and use a light fixture 500 hours per year. What is the break-even cost per
kilowatt-hour? (Do not round intermediate calculations and round your final answer to 6 decimal places (e.g.,
32.161616).)

Break-even cost$

9.Compact fluorescent lamps (CFLs) have become more popular in recent years, but do they make financial sense?Suppose a typical 60-watt incandescent light bulb costs $.39 and lasts for 1,000 hours. A 15-watt CFL, whichprovides the same light, costs $3.10 and lasts for 12,000 hours. A kilowatt-hour is 1,000 watts for 1 hour. Supposeyou have a residence with a lot of incandescent bulbs that are used on average 500 hours a year. The average bulbwill be about halfway through its life, so it will have 500 hours remaining (and you can’t tell which bulbs are olderor newer).

If you require a 11 percent return, at what cost per kilowatt-hour does it make sense to replace your incandescent
bulbs today? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations
and round your final answer to 6 decimal places, e.g., 32.161616.)

Break-even cost