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Capital Equipment Financing Options and Investment Analysis

Evaluate financing options for a $2.8 million capital equipment purchase and analyze investment opportunities with different returns.

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Capital Equipment Financing Options and Investment Analysis

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  1. Your company needs to make a $2,800,000 purchase of capital equipment. This can be financed either by a 5-year bank loan for the whole amount, or by $1,200,000 of your company’s own money plus a three-year loan of $1,600,000 from a trust company. If you take the bank loan, you will be charged 12% nominal annual interest, compounded half-yearly, and you will pay the loan off in ten equal half-yearly payments. If you take the loan from the trust company, you will be charged x% annual interest. At the end of Years 1 and 2, you pay back the interest accumulated to date, and at the end of the third year you pay back the $1,600,000 plus any additional interest. Your pre-tax MARR is 21%. What is the present value of the bank loan? (5 points) What is the present value of the trust loan if x=10%? (5 points) c) For what value of x are the two options economically equivalent? (10 points)

  2. You have $20,000 to invest, and you have a choice between three investment opportunities. One of these involves an immediate cost of $10,000 and a return of $14,400 in two years time. The second involves an immediate cost of $20,000, with a return of $26,500 in two years time. The third alternative is putting money in the bank, where it will earn 9% annual interest. • What is the IRR of the first option? (7 points) • What is the IRR of the second option? (7 points) • What is the incremental IRR of upgrading from the first option to the second option? (10 points) • Which option should you choose? (6 points)

  3. Upgrading from Option 1 to Option 2 has an IRR of 10%; this is greater than the 9% we can get from the bank, so we should do it. We confirm this conclusion by comparing how much money we have in two year’s time, if we take Option 2, or if we take Option 1 and put rest in the bank:

  4. (From APEGBC Exam, Dec 2003, #2) Two proposals are submitted for constructing a new toll road. The financial information related to the projects is as shown on the following table, in millions of dollars: Find: a) the B/C ratio for Project A b) The B – C value of Project B c) Which project, if either, should the government choose? Assume an interest rate of 5%

  5. (From APEGBC Exam, May 2004, #2) The operating and maintenance costs of the air cleaning, air supply and exhaust system for a silver mine in New Mexico are $300,000 in the first year of operation, and are expected to increase by 10% in each subsequent year. The initial cost of the system, including installation, is $900,000, and the physical life of the system is 5 years. Its salvage value is zero and it would cost $100,000 to remove it. The company’s MARR is 8%. Determine: a) the annual cost of the system if it is replaced after three years of use b) the economic life of the system c) the yearly saving if the system is replaced at the end of its economic life, rather than after three years.

  6. (From APEGBC Exam, Dec 2004, #2) A company is considering three mutually exclusive alternatives for upgrading its mining equipment. The cashflows associated with each proposal, in $M, are shown below. Equipment salvage values are zero. The company’s MARR is y%. Determine: a) the equivalent uniform annual savings if we choose Option 2 and y = 10% b) the preferred alternative using the future worth method, y = 10% c) the preferred alternative using the IRR method, y = 8%

  7. (From APEGBC Exam, Dec 2004, #3) The Vice-President of Atlas Inc. prepared a proposal for a new manufacturing facility in Halifax for producing pumps. The financial information for this project is given below: Project Life: 5 years Initial Equipment cost: $10M Anticipated net annual revenue: $2.6M Preventive maintenance costs at the end of years 2 and 4: $X Salvage Value: $1.5M MARR: 12% CCA rate for equipment: 30% Tax rate: 40% Determine: a) the max. value of X for the project to be acceptable, pre-tax b) the pre-tax IRR of the project if X = 0 c) the CCA and terminal loss or gain in the final year of the project d) the income tax payable in the first year of the project e) The after-tax cashflow in the second year of the project if X = $0.1M

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