PROBLEM 13-9 NEW PROJECT ANALYSIS

You must evaluate a proposal to buy a new milling machine. The base price is $108,000, and
shipping and installation costs would add another $12,500. The machine falls into the MACRS3-
year class, and it would be sold after 3 years for $65,000. The applicable depreciation rates are
33%, 45%, 15%, and 7% as discussed in Appendix 12A. The machine would require a $5,500
increase in net operating working capital (increased inventory less increased accounts payable).
There would be no effect on revenues, but pretax labor costs would decline by $44,000 per year.
The marginal tax rate is 35%, and the WACC is 12%. Also, the firm spent $5,000 last year
investigating the feasibility of using the machine.

a. How should the $5,000 spent last year be handled?

Biaya sebesar $5,000 yang dikeluarkan untuk melakukan investigasi kelayakan penggunaan
mesin adalah sunk costs sehingga seharusnya tidak dimasukkan ke dalam analisis capital
budgeting.

b. What is the initial investment outlay for the machine for capital budgeting purposes, that
is, what is the Year 0 project cash flow?

Investment Outlays at Time = 0

New machine cost -$108,000
Shipping and installation costs -12,500
ΔNOWC -5,500
Cash outlay for new machine -$126,000

c. What are the project's annual cash flows during Years 1, 2, and 3?
 After-tax cost savings = EBIT Cost Savings (1-T)
= $44,000 (1 - 0.35)
= $44,000 (0.65)
= $28,600
 Depreciation expense in each year = Depreciable basis x MARC allowance %
Year 1 = $120,500 x 33% = $39,765
Year 2 = $120,500 x 45% = $54,225
Year 3 = $120,500 x 15% = $18,075

 Depreciation tax savings = Depreciation expense x Tax rate (35%)

Year 1 = $39,765 x 0.35 = $13,918
Year 2 = $54,225 x 0.35 = $18,979

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 Year 3 = $18,075 x 0.35 = $6,326

 Book value = $120,500 x 7% = $8,435

 Taxes on salvaged value = Tax rate x (Salvage value – Book value)
= 0.35 x ($65,000 - $8,435)
= 0.35 x $56,565
= $19,797.75 = $19,798

Project's annual cash flows during Years 1, 2, and 3:

Year 1 Year 2 Year 3
$28,60
After-tax savings 0 $28,600 $28,600
Depreciation tax savings 13,918 18,979 6,326
Salvage value 65,000
Taxes paid on salvaged value -19,798
ΔNOWC 5,500
$42,51
Cash flow 8 $47,579 $85,628

d. Should the machine be purchased? Explain your answer.

NPV dicari dengan menggunakan formula Excel
=NPV(rate; value 1; [value 2], ...)
 =NPV(0.12; 42,518; 47,579; 85,628) + -126,000

NPV = $10,840.51
Dengan melihat NPVnya yang positif, maka seharusnya pembelian mesin dilakukan.

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PROBLEM 13-11 REPLACEMENT ANALYSIS
Mississippi River Shipyards is considering the replacement of an 8-year-old riveting machine
with a new one that will increase earnings before depreciation from $27,000 to $54,000 per year.
The new machine will cost $82,500, and it will have an estimated life of 8 years and no salvage
value. The new machine will be depreciated over its 5-year MACRS recovery period, so the
applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. The applicable corporate tax
rate is 40%, and the firm's WACC is 12%. The old machine has been fully depreciated and has no
salvage value. Should the old riveting machine be replaced by the new one? Explain your answer.

Jawab:
 Investment Outlays at Time = 0
New machine cost -$82,500
-$82,500
 After-tax project earnings = EBIT (1-T)  Increase in earnings
= $27,000 (1 - 0.4)
= $27,000 (0.6)
= $16,200
 Δ Depreciation = Depreciation on the new machine, karena mesin lama sudah terdepresiasi
sepenuhnya.
Year 1 = $82,500 x 20% = $16,500
Year 2 = $82,500 x 32% = $26,400
Year 3 = $82,500 x 19% = $15,675
Year 4 = $82,500 x 12% = $9,900
Year 5 = $82,500 x 11% = $9,075
Year 6 = $82,500 x 6% = $4,950
Year 7 = $82,500 x 0% = $0
Year 8 = $82,500 x 0% = $0

 Depreciation tax savings = Δ Depreciation x Tax rate (40%)

Year 1 = $16,500 x 0.4 = $6,600
Year 2 = $26,400 x 0.4 = $10,560
Year 3 = $15,675 x 0.4 = $6,270
Year 4 = $9,900 x 0.4 = $3,960
Year 5 = $9,075 x 0.4 = $3,630

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 Year 6 = $4,950 x 0.4 = $1,980
Year 7 = $0 x 0.4 = $0
Year 8 = $0 x 0.4 = $0

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8

After-tax project $16,20
earnings $16,200 $16,200 $16,200 $16,200 $16,200 $16,200 $16,200
0
Depreciation tax savings
6,600 10,560 6,270 3,960 3,630 1,980 0 0
$26,76
Cash flow $22,800 0 $22,470 $20,160 $19,830 $18,180 $16,200 $16,200

 Mencari NPV dengan menggunakan formula Excel

=NPV(rate; value 1; [value 2], ...)
=NPV(0.12; 22,800; 26,760; 22,470; 20,160; 19,830; 18,180; 16,200; 16,200) + -82,500
 NPV = $22,329

Dengan melihat NPVnya yang positif, maka sebaiknya penggantian riveting machine
yang lama dengan mesin yang baru dilakukan.

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PROBLEM 13-12 PROJECT RISK ANALYSIS
The Butler-Perkins Company (BPC) must decide between two mutually exclusive projects. Each
costs $6,750 and has an expected life of 3 years. Annual project cash flows begin 1 year after the
initial investment and are subject to the following probability distributions:

Project A Project B
Probability Cash Flows Probability Cash Flows
0.2 $6,000 0.2 $0
0.6 $6,750 0.6 $6,750
0.2 $7,500 0.2 $18,000

BPC has deciced to evaluate the riskier project at 12% and the less-risky project at 10%.

a. What is each project’s expected annual cash flow? Project B’s standard deviation (σ B) is
$5,798, and its coefficient of variation (CVB) is 0.76. What are the values of σA and CVA?

Jawab:
Expected annual cash flow untuk project A dan B adalah sebagai berikut.
Project A
Probability x Cash Flows Expected Cash Flows
0.2 x $6,000 $1,200
0.6 x $6,750 $4,050
0.2 x $7,500 $1,500
Expected annual cash flow $6,750

Project B
Probability x Cash Flows Expected Cash Flows
0.2 x $0 $0
0.6 x $6,750 $4,050
0.2 x $18,000 $3,600
Expected annual cash flow $7,650

Standar deviation dan CV dari project A adalah sebagai berikut.

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 Squarred Probability of Probability x
Expected Deviations from
Cash Flows Deviations from This Demand Squarred
Cash Flows the Mean
the Mean Ocurring Deviations
$6,000 $6,750 -$750 $562,500 0.2 $112,500
$6,750 $6,750 $0 $0 0.6 $0
$7,500 $6,750 $750 $562,500 0.2 $112,500
Variance ሺʍଶ) $225,000

Standard deviation (σ) $474.34

Divide by expected return - mean $6,750
Coefficient of variation (CV) 0.0703

Standar deviation dan CV dari project B adalah sebagai berikut.

Squarred Probability of Probability x

Expected Deviations from
Cash Flows Deviations from This Demand Squarred
Cash Flows the Mean
the Mean Ocurring Deviations
$0 $7,650 -$7,650 $58,522,500 0.2 $11,704,500
$6,750 $7,650 -$900 $810,000 0.6 $486,000
$18,000 $7,650 $10,350 $107,122,500 0.2 $21,424,500
Variance ሺʍଶ) $33,615,000

Standard deviation (σ) $5,797.84

Divide by expected return - mean $7,650
Coefficient of variation (CV) 0.7579

b. Based on the risk-adjusted NPVs, which project should BPC choose?

Jawab:
Project B adalah project yang lebih berisiko karena memiliki standar deviasi dan CV yang lebih
tinggi daripada project A. Oleh karena itu, WACC dari project B seharusnya lebih tinggi dari
project A. Jadi, WACC project B adalah 12% sedangkan WACC untuk project A adalah 10%.
Untuk menentukan project mana yang seharusnya dipilih oleh BPC, maka perlu dilakukan
perhitungan NPV untuk keduanya sebagai berikut:

Project A - WACC = 10%

Period Cash Flow Discount Factor Discounted Cash Flow
0 -$6,750 ሺͳǤͳሻ଴ -$6,750.00
1 $6,750 ሺͳǤͳሻଵ $6,136.36
ଶ
2 $6,750 ሺͳǤͳሻ $5,578.51
ଷ
3 $6,750 ሺͳǤͳሻ $5,071.37
Total (NPV) $10,036.25

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 Project B - WACC = 12%
Period Cash Flow Discount Factor Discounted Cash Flow
0 -$6,750 ሺͳǤͳʹ ሻ଴ -$6,750.00
1 $7,650 ሺͳǤͳʹ ሻଵ $6,830.36
2 $7,650 ሺͳǤͳʹ ሻଶ $6,098.53
ଷ
3 $7,650 ሺͳǤͳʹ ሻ $5,445.12
Total (NPV) $11,624.01

BPC seharusnya lebih memilih project B karena memiliki NPV yang lebih tinggi
dibandingkan dengan project A.

c. If you knew that Project B’s cash flows were negatively correlated with the firm’s other cash
flows, but Project A’s cash flows were positively correlated, how might this affect decision? If
Project B’s cash flows were negatively correlated with gross domestic product (GDP), while
A’s cash flows were positively correlated, would that influence your risk assessment?

Jawab:

Informasi tersebut seharusnya tidak akan mempengaruhi keputusan BPC untuk tetap lebih
memilih project B. Justru informasi tersebut akan lebih menguatkan pilihan BPC pada project
B. Hal ini disebabkan hubungan yang negatif dengan cash flow project lain akan mengurangi
risiko cash flow dalam diversifikasi project yang dimiliki perusahaan. Hal ini juga berlaku
untuk cash flow project B yang berkorelasi negatif dengan GDP, artinya saat perekonomian
sedang lesu, project B justru akan menghasilkan keuntungan (lebih profitable). Korelasi negatif
ini akan bermanfaat dalam menurunkan risiko untuk portofolio project dari perusahaan secara
keseluruhan.

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PROBLEM 13-13 UNEQUAL LIVES
Haley’s Graphic Designs Inc. is considering two mutually exclusive projects. Both projects require
an initial investment of $10,000 and are typical average-risk projects for the firm. Project A has an
expected life of 2 years with after-tax cash inflows of $6,000 and $8,000 at the end of Years 1 and
2, respectively. Project B has an expected life of 4 years with after-tax cash inflows of $4,000 at the
end of each of the next 4 years. The firm’s WACC is 10%.

a. If the projects cannot be repeated, which project should be selected if Haley uses NPV as its
criterion for project selection?
Jawab:

0 1 2
I I I
Project A -$10,000 $6,000 $8,000
PV 10% -$10,000 $5,454.55 $6,611.57
NPV $2,066.12

0 1 2 3 4
I I I I I
Project B -$10,000 $4,000 $4,000 $4,000 $4,000
PV 10% -$10,000 $3,636.36 $3,305.79 $3,005.2 $2,732.05
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NPV $2,679.46

Berdasarkan hasil perhitungan NPV, Project B menghasilkan NPV lebih tinggi dibandingkan
Project A, karena project tidak dapat diulang maka Project B yang dipilih.

b. Assume that the projects can be repeated and that there are no anticipated changes in the cash
flows. Use the replacement chain analysis to determine the NPV of the project selected.

Jawab:
Pada metode replacement chain analysis, dengan asumsi project dapat diulang, maka perlu
dihitung ulang NPV Project A dengan jangka waktu yang sama dengan Project B sebagai
berikut:

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 0 1 2 3 4
I I I I I
Project A -$10,000 $6,000 $8,000
-$10,000 $6,000 $8,000
Time Line -$10,000 $6,000 -$2,000 $6,000 $8,000
PV 10% -$10,000 $5,454.55 -$1,652.89 $4,507.8 $5,464.11
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NPV $3,773.65

Dari hasil perhitungan diperoleh NPV Project A sebesar $3,773.65, nilai tersebut lebih besar
dari NPV Project B $2,679.46 sehingga Project A yang lebih dipilih.

c. Make the same assumptions as in part b. Using the equivalent annual annuity (EAA) method,
what is the EAA of the project selected?

Jawab:
Berdasarkan asumsi pada part b, menggunakan metode Equivalent Annual Annuity (EAA)
dapat dicari nilai PMT / EAA dari setiap project dengan menggunakan formula excel
=PMT(rate; nper; pv; [fv]; [type]), sehingga diperoleh hasil sebagai berikut:

Project A Project B
rate 10% 10%
nper 4 4
Pv $3,773.65 $2,679.46
fv 0 0
type end of the period end of the period
PMT $1,190.48 $845.29

Dari hasil perhitungan tersebut diperoleh nilai aliran kas masuk Project A lebih besar
dibandingkan dengan Project B sehingga Project A lebih dipilih.