Suppose a company has hired you to estimate the cash flows arising from a proposed capital project by replacing old equipment with a $0 market value and a book value of $6000, and you have been handed the relevant data below. The project being considered has a 5-year tax life, and at the end of year 5 the asset will be worthless (i.e. salvage value =0). The CFO suggests that you depreciate the asset by using the straight-line method over the 5 year life of the project. Revenues and other operating costs are as noted below, and will be constant over the period.

Equipment cost: $150,000; Book value of old equipment: $6000

Delivery and installation cost of equipment and remove old equipment: $50,000;

Straight-line depreciation rate: 20% (5-year); Sales revenue each year: $100,000

Operating costs (excluding depreciation): $30,000; Tax rate: 40%

a. What are annual cash flows for the next five years? Hint: find CF0 to CF5

b. Suppose CFO will borrow 50% of capital from a bank with 10% interest, and 50% of capital through equity with 22% of require rate of return. What is the cost of capital for this project?

c. What is the net present value of this project and should you convince the CFO to accept or reject the new equipment?

Answer rating: 100% (QA)

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