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Chapter 8

117

20.

Capital budgeting decisions that involve both a decrease in working capital and an increase in fixed assets are most likely to be confronted bycompanies a moving toward the ITT ideal of zero inventories. b. whose primary activity is selling services. c. considering relaxing the credit terms granted to customers.d. seeking to shorten the payment periods on their purchases of merchandise for resale .

APPLICATIONS

PROBLEM 1

You are given the following.
Cost of new machineryUseful life Annual pretax cash operating savings
$725,000
8 years
$200,000

The company uses straight-line depreciation for tax purposes. The tax rate is 40% andcost of capital is 12%.

Required:
(a) Determine the increase in annual net cash flow.
$----­

(b) Determine the project's net present value.

$----­

(c)Determine the project's profitability index, rounded to two decimal places.

(d) Determine the minimum cost savings needed to provide a 12% internal rate of return on theinvestment. $ ----­

118

Chapter 8

PROBLEM 2
The following data apply to new machinery that the production manager of Indianhead, Inc. wants to purchase. Cost ofmachinery Expected useful life MACRS class Expected annual cash savings, before taxes Income tax rate Cost of capital Salvage value $400,000
10 years
7 years
$100,000
35%14%
none

Required
(a) Determine the present value ofMACRS tax shield. (Use Exhibit 8-2 in the text.)

$----­

(b) Determine the annual net cash flow, exclusiveofMACRS tax shield. $ _~

_

(c) Determine the present value of your answer to part b.

$---~-

(d) Determine the net present value of the investment.

$----­

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