Exam 2 Finance 470 Key
Exam 2 Finance 470
1. When is EAC analysis appropriate for comparing two or more projects? Why is this method used? Are there any implicit assumptions required by this method that you find troubling? Explain.
The EAC approach is appropriate when comparing mutually exclusive projects with different lives that will be replaced when they wear out. This type of analysis is necessary so that the projects have a common life span over which they can be compared; in effect, each project is assumed to exist over an infinite horizon of N-year repeating projects. Assuming that this type of analysis is valid implies that the project cash flows remain the same forever, thus ignoring the possible effects of, among other things: (1) inflation, (2) changing economic conditions, (3) the increasing unreliability of cash flow estimates that occur far into the future, and (4) the possible effects of future technology improvement that could alter the project cash flows.
2. The Army has requested a bid for multiple use digitizing devices (MUDDs). They will require the winner of the bid to deliver 4 units each year for the next 3 years. You have estimated that labor and materials costs will be $10,000 per unit. Production space can be leased for $12,000 per year. The project will require $50,000 in fixed assets with expected salvage of $10,000 at the end of the project (depreciate straight-line to salvage value) and an initial $10,000 increase in NWC. Your marginal tax rate = 34% and the required return = 15%. What is your minimum bid?
NPV = 0 = -60,000 + OCF(PVIFA15%,3) + 20,000(PVIF15%,3)
NPV = 0 = -60,000 + (NI + Dep)(2.2832) + 20,000(0.6575)
NPV = 0 = -60,000 + [(S – VC – FC - Dep)(1 – T) + Dep](2.2832) + 13,150.32
46,849.68 = [(4P – 4(10,000) – 12,000 – 13,333.33)(1 - .34) + 13,333.33](2.2832)
20,519.31 = (4P – 65,333.33)(0.66) + 13,333.33
7,185.98 = (4P – 65,333.33)(0.66)
10,887.85 = 4P – 65,333.33
76,221.18 = 4P
19,055.21 = P
1. When is EAC analysis appropriate for comparing two or more projects? Why is this method used? Are there any implicit assumptions required by this method that you find troubling? Explain.
The EAC approach is appropriate when comparing mutually exclusive projects with different lives that will be replaced when they wear out. This type of analysis is necessary so that the projects have a common life span over which they can be compared; in effect, each project is assumed to exist over an infinite horizon of N-year repeating projects. Assuming that this type of analysis is valid implies that the project cash flows remain the same forever, thus ignoring the possible effects of, among other things: (1) inflation, (2) changing economic conditions, (3) the increasing unreliability of cash flow estimates that occur far into the future, and (4) the possible effects of future technology improvement that could alter the project cash flows.
2. The Army has requested a bid for multiple use digitizing devices (MUDDs). They will require the winner of the bid to deliver 4 units each year for the next 3 years. You have estimated that labor and materials costs will be $10,000 per unit. Production space can be leased for $12,000 per year. The project will require $50,000 in fixed assets with expected salvage of $10,000 at the end of the project (depreciate straight-line to salvage value) and an initial $10,000 increase in NWC. Your marginal tax rate = 34% and the required return = 15%. What is your minimum bid?
NPV = 0 = -60,000 + OCF(PVIFA15%,3) + 20,000(PVIF15%,3)
NPV = 0 = -60,000 + (NI + Dep)(2.2832) + 20,000(0.6575)
NPV = 0 = -60,000 + [(S – VC – FC - Dep)(1 – T) + Dep](2.2832) + 13,150.32
46,849.68 = [(4P – 4(10,000) – 12,000 – 13,333.33)(1 - .34) + 13,333.33](2.2832)
20,519.31 = (4P – 65,333.33)(0.66) + 13,333.33
7,185.98 = (4P – 65,333.33)(0.66)
10,887.85 = 4P – 65,333.33
76,221.18 = 4P
19,055.21 = P