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You are buying a car. No Better Deals will give you $500 off the list price on a $10,000 car.

a. You can get the same car from Best Deals if you pay $4,00 down and the rest at the end of two years. If the interest rate were 12 percent, where would you buy the car?

b. Best Deals has revised its offer. You now pay $2,000 down, $3,000 at the end of the first year and $5,000 at the end of the second year. If the interest rate were still 12 percent, where would you buy the car?

c. No Better Deals, in turn makes a new offer. You pay $10,000, but you can borrow the sum from the dealer at 0.5 percent per month, with the first payment made when the car is delivered. If you accept the offer, (1) what would you monthly payments be? (2) What would the cost of the car to you be?

5. The case of multiple internal rates of return.

The International Industrial Company has an investment project with the following cash flows

Time Cash Flow Type of Case Flow
Now -$200 Purchase of Equipment
End of Year 1 $600 Cash earnings from project
End of Year 2 -$400 Cash earning from project less clean up cost

a. What is the new present value of these cash flows at 0, 25, 50 and 100 percent discount rate?

b. What is the internal rate of the return of this project?

c. Under what condition should the project be accepted?

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8. The net present value rule versus the profitability index rule.
(You must choose between the two projects whose cash flows are show below. The projects have the same risk)

Time Project A Project B
Now -$16,000 -$3,200
End of Year 1 $10,500 $3,300
End of Year 2 $9,100 $1,260
End of Year 3 $3, 000 $600

a. Compute the net present value (NPV) and the profitability index (PI) for the two projects. Assume 10 percent is the discount rate.

b. Which of the projects is better according to each of the two methods?

c. What is the explanation for the differences in rankings between the NPV and PI methods of analysis?

d. Which method is correct? Explain why.

Changing machines in a world without taxes.

The Clampton Company is considering the purchase of a new machine to perform operations currently being performed on different, less efficient equipment. The purchase price is $110,000, delivered and installed. A Clampton production engineer estimates that the new equipment will produce savings of $30,000 in labor and other direct costs annually, compared with the present equipment. He estimated the proposed equipment’s economic life at five years, with zero salvage value. The present equipment is in good working order and will last, physically, for at least ten more years. The company requires a return of at least 10 percent before taxes on an investment of this type. (Taxes are to be disregarded)

a. Assuming the present equipment has zero book value and zero resale value, should the company buy the proposed piece of equipment?

b. Assuming the present equipment is being depreciated at a straight line rate of 10 percent, that is, it has a book value of $40,000 (cost, $80, 000; accumulated depreciation, $40,000) and has zero net resale value today, should the company buy the proposed equipment? Explain why or why not.

The Clampton Company decides to purchase the equipment, hereafter called Model A. Two years later, even better equipment (Called Model B) is available on the market and makes the other equipment completely obsolete, with no resale value. The Model B equipment costs $150,000 delivered and installed, but it is expected to result in annual savings of $40,000 over the cost of operating the Model A equipment. The Economic life of Model B is estimated to be five years. It will be depreciated at a straight-line rate of 20 percent.

c. What action should the company take?

d. The company decides to purchase the Model B equipment, but a mistake has been made somewhere, because good equipment, bought only two years previously, is being scrapped. How did this mistake come about?

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