2-8 INTRODUCTORY PROJECT VALUATION South Tel Communications is

considering the purchase of a new software management system. The system is called B-
Image, and it is expected to reduce drastically the amount of time that company technicians
spend installing new software. South Tel’s technicians currently spend 6,000 hours per year
on installations, which costs South Tel $25 per hour. The owners of the B-Image system
claim that their software can reduce time on task by at least 25%. The system requires an
initial investment of $55,000 and an additional investment of $10,000 for technician training
on the new system. Annual upgrades will cost the firm $15,000 per year. The tax treatment of
software purchases sometimes calls for amortization of the initial cost over time; sometimes
the cost can be expensed in the year of the purchase. Before the tax experts are consulted and
for purposes of this initial analysis, South Tel has decided that it will expense the cost of the
software in the year of the expenditure. South Tel faces a 30% tax rate and uses a 9% cost of
capital to evaluate projects of this type.
a. Assume that South Tel has sufficient taxable income from other projects so that it can
expense the cost of the software immediately. What are the free cash flows for the project for
years zero through five?
b. Calculate the NPV and IRR for the project.

2-9 INTRODUCTORY PROJECT VALUATION The CT Computers Corporation is

considering whether to begin offering customers the option to have their old personal
computers (PCs) recycled when they purchase new systems. The recycling system would
require CT Computers to invest $600,000 in the grinders and magnets used in the recycling
process. The company estimates that for each system it recycles, it would generate $1.50 in
incremental revenues from the sale of scrap metal and plastics. The machinery has a five-year
useful life and will be depreciated using straight-line depreciation toward a zero salvage
value. CT Computers estimates that in the first year of the recycling investment, it could
recycle 100,000 PCs and that this number will grow by 25% per year over the remaining
four-year life of the recycling equipment. CT Computers uses a 15% discount rate to analyze
capital expenditures and pays taxes equal to 30%.
a. What are the project cash flows? You can assume that the recycled PCs cost CT Computers
nothing.
b. Calculate the NPV and IRR for the recycling investment opportunity. Is the investment a
good one based on these cash flow estimates?
c. Is the investment still a good one if only 75,000 units are recycled in the first year?
d. Redo your analysis for a scenario in which CT Computers incurs a cost of $0.20 per unit to
dispose of the toxic elements from the recycled computers. What is your recommendation
under these circumstances?
2-10 PROJECT VALUATION Glentech Manufacturing is considering the purchase of an
automated parts handler for the assembly and test area of its Phoenix, Arizona, plant. The
handler will cost $250,000 to purchase plus $10,000 for installation. If the company
undertakes the investment, it will automate part of the semiconductor test area and reduce
operating costs by $70,000 per year for the next ten years. Five years into the life of the
investment, however, Glentech will have to spend an additional $100,000 to update and
refurbish the handler. The investment in the handler will be depreciated using straight-line
depreciation over ten years, and the refurbishing costs will be depreciated over the remaining
five-year life of the handler (also using straight-line depreciation). In ten years, the handler is
expected to be worth $5,000, although its book value will be zero. Glentech’s tax rate is
30%, and its opportunity cost of capital is 12%. Exhibit P2-10.1 contains cash flow
calculations for the project that can be used in performing a DCF evaluation of its
contribution to firm value. Answer each of the following questions concerning the project:
a. Is this a good project for Glentech? Explain your answer.
b. What can you tell about the project from the NPV profile found in Exhibit P2-10.1?
c. If the project were partially financed by borrowing, how would this affect the investment
cash flows? How would borrowing a portion of the investment outlay affect the value of the
investment to the firm?
d. The project calls for two investments: one immediately and one at the end of year 5. How
much would Glentech earn on its investment? How should you account for the additional
investment outlay in your calculations?
e. What are the considerations that make this investment somewhat risky? How would you
investigate the potential risks of this investment?