Pax Il BLT. Exam Review Questions 407 (0) Select either one (A) Select neither (26) A series of five constant-dollar (or real dolla) payments begin- ning with $6,000 at the end of the first vear are increasing at the rate of 9% per year. Assume that the average general inBa- tion rate is 4% and the market (inflation-adjusted) interest rate is 11% dating this inflationary period. What is the equivalent present worth of the series? (a) $24,250 (b) $95,802 (e) $27,201 (4) $29,406 (27) “At a market interest rate of 7% per year and an inflation rate of 5% per year, a series of 3 equal annual receipts of $100 in constant dollars is equivalent to a series of 3 annual receipts of $105 in actual dollars.” (a) The amount of actual dollars is overstated (b) The amount of actual dollars is understated, (©) The amount of actual dollars ie about right. (d) There is not suficient information to compare, (28) Consider the following two mutually exclusive service projects ‘with individual lives of 3 years and 2 yeare, zespectively. (Mu- tually exclusive service projects will have identical revenes for each year of service.) The interest rate is known to be 6%. Net Cash Flow Bad of Year Project A Project B a $1,000 $2,000 1 ~400 =150 : 2 _ ~400 150 + 0 (salvage) 3 =400 + 200 (savage)408 Part Il. BLT. Bxam Review Questions If the required service period is indefinite (infinite) and both projects ean be repeated with the given coals, which project is the better choice? Project A (b) Project B (©) Indifferent (@) Neither (29) Two options are available for painting your house: (1) cil-based painting which eosts $5,000 and (2) water-based painting which costs $3,000. ‘The estimated lives are 10 years and 8 years re spectively. For either option, there is no salvage value at the end of respective service life. Assume that you will keep and maintain the house for 10 years. If your personal interest cate is 10% per year, which of the following statements is correct? (a) On annual basis, Option 1 will cost about $850 (b) On anaval bass, Option 2is about $22 cheaper than Option 1 (©) On annwal basis, both options cost about the same. (@) On annual basis, Option 2 wll cost about $820. (80) A sill press machine ean be purchased at $100,000 and is ex pected to have a constant salvage value of $20,000 regardless of Its age. ‘The operating cost forthe frst year is expected to be '$40,000 and it will then increase $20,000 per year, as @ result of degrading eiciency. Ifthe interest raie i 10%, determine the economic service life ofthe dill press machine. (Assume that all coat igures and salvage value are given on an afer-tax basis.) (a) 2 years (b) 3 years (c) 4 years (d) 5 yearsPort Il, B:1-7. Exam Keview Questions uy (31) Bight years ago, a company purchased an injection molding machine at $40,000. It has been depreciated according to she straight-line method over a 12-year service life. The estimaied salvage value at the end of 12 years (from the purchase) was $4,000. This estimate is still good. The machine has a current _ ‘market value of $15,000, If the machine is sold on the market, what would be the net proceeds (net salvage value after tax) from the sale? The firm's income tax rate is 40%. Any gains (or losses) will be taxed (or credited) at 40%. (a) $15,000 (b) $13,800 (©) $9,000 (a) 811,000 Problem Staiement for (82) - (34) A machine, purchased for $45,000, hhad a depreciable life of 4 years. It will have an expected salvage value of $5,000 at the end of the depreciable lite (32) Under the straight-line method, what is the book value at the fend of year 27 (a) 827500 (b) $20,000 (©) $35,000 (4) 825900 (33) Under the double decining balance (200% DB) method, what is the depreciation amount for year 27 (a) $10,000 (b) $11,250 () $20,000 (a) $17,500 (84) Under the sum of the year’s-digits (SOYD) method, what is the depreciation amount for year 2?aww Fart. B11. Bxam Neview Questions (a) $11,000 () $10,000 (e) $12,000 (a) $18,000 (5) You are considering purchasing @ CNC machine which costs $150,000. This machine will have an estimated service lie of 10 years with a net after-tax salvage value of $15,000. Its annual ‘after tax operating and maintenance costs (considering depre- ciation tax shields) are estimated to be $50,000. To expect an 18% rate of return on investment (after-tax), what would be the required minimum annual after-tax revenues? (a) $63,500 (b) $82,740 (c) $92,435, (4) $94,508 (36) You are considering purchasing industrial equipment to expand ‘one of your production lines. The equipment costs $100,000 and has an eatimated service life of 6 years. Assuming that the ‘equipment will be financed entirely from your business retained earnings (equity fonds), the engineer has calculated the expected after tax cash lows including the salvage value at the end of its project life as follows: End of Year Net Cosh Flow 0 $100,000, 1-8 $500,000, 6 $600,000, Now you ace pondering the possibility of financing the entire amount by borrowing from a local bank at 12% interest. You can make an arrangement to pay only interest each year over the project period by deferring the principal payment until the endof 6 years, Your firm's interest rate is also 12%. The expected ‘marginal income tax rate over the project period is known to be 40%, What is the amount of gain (or loss) in present worth by debt financing? (a)-40 ——- (b) $18,000 (6) $19,735, (a) $22,350 (37) A corporation is considering purchasing a machine that will save $130,000 per year before taxes. The cost of operating the ma- chine, including maintenance, is $20,000 per year. ‘The machine will be needed for 4 years, after which it will have a zero sal- vage value, MACRS depreciation will be used assuming « 3-year ‘lass ife. The allowed depreciation amount in percentage of the initial cost will be 38.38%, 44.45%, 14.81%, and 7.41%, respec: tively. If the firm wants « 12% rate of return after taxes, how such ean they afford to pay for this machine? The firm's income tax rate is 40%, (a) $300,000 (b) $850,800 (e) $400,750 (a) $495,245, Problem Statement for Questions (38) - (40) A machine now in use which was bought 5 years ago at $4,000 has been fully de preciated. It can be sold for $2,500, but could be used for 3 more ‘years (remaining useful life), at the end of which time it would have no salvage value. The annual operating and maintenance costs amount to $10,000 for the old machine. A new machine ‘ean be purchased at an invoice price of 814,000 to replace the present equipment. Because of the nature of the product man: ‘ufactured, it also has an expected economic life of 3 years, and will have no salvage valde at the end of that time, With the newaz Part I, BLT. Exam Review Questions ‘machine, the expected operating and maintenance costs amount to $2,000 for the first year and $3,000 in each of the next. two years, The income tax rate is 349%. Any capital gains will also bbe taxed at 24%. The allowed depreciation amounts for the new ‘machine are $1,400 during the first year, and $2,800 per year for the next two years. The firm's interest rate is 15%. 7 (88) Ifthe old mochine is to be sold now, the gain tax will be (a) $800 (b) $880 (©) $900 (a) $980 (39) 1f you decide to retain the old machine for now, what is the opportunity east? (a) $2,500 (&) $4,000 (e) 81,880 (4) $1,500 (40) What is the incremental annual after-tax Benefit of replacing the old machine? (a) 8909 (b) $918 (6) $036 (a) 8972Part Il. E.LT, Exam Review Questions Answers to E.LT. Review Questions Question | Answer [ Question | Answer T € a b 2 > 2 a so Bact 23. | bh 4 b Pa b 5 é cy a 6 a 26 . 7 a 2 b 8 a 28 . 9 > 9 b 10 a 30 b n e 3 8 2 © 32 a iB b 33 b 1“ « o © % € 35 > 6 a 36 © Mw © 37 ’ 18 © 38 ’ 19 e 39 « 20 « 40 b