1. Explain the implication of M & M (1963) propositions I, II and III in tax world using appropriate diagram.

2. Zaffers Ltd. Is considering buying a new machine with a price of $18M to replace its existing machine. The current machine has a book value of $6M and a market value of $4.5M. The new machine is expected to have a four-year life, the old machine has four years left in which it can be used. If the firm replaces the old machine with a new one. It expects to save $6.7M in operating costs each year over the next four years. Both machines will have no salvage value in four years. If the firm purchases the new machine it will also need and investment of $2.5M in net working capital. The replaced rate on the investment is 10% and the tax rate is 30%.

1. The initial cash flow at year 0.

2. The net cash flows in year 1 to 3.

3. The net cash flow in year 4.

4. The NPV.

5. Whether the firm should replace the old machine with new machine?