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FINM 1001: Money Markets and Finance

Making Investment Decisions: Practice Questions

Question One

A corporation is considering installing a machine that costs $100,000 plus installation costs of $10,000. It will generate revenues of $200,000 annually and cash expenses annually of $100,000. It will be depreciated to a salvage value of $5,000 over a seven-year life using the straight-line method. Assuming the firm is in a 34% marginal tax bracket, determine the incremental cash flows of this investment project.

Question Two

A corporation is considering purchasing one of two machines, A and B. The cash flows of each of the projects are represented below. The project’s required rate of return is 10% p.a.. Since these projects are mutually exclusive, which proposal (if any) should the manufacturer choose?

Question Three

A firm is considering two types of machines to produce its output. Machine X is more expensive and lasts longer than Machine Y. The net cash flows (ie, revenues less expenses after tax) generated by each of the two machines are tabulated below.  

Assuming that the required return is 10% p.a. and that the machine that is adopted will be replaced indefinitely, what should the firm do?

Question Four

An office is considering an optimal replacement policy for its copying machines. The cost of running a machine for its three year life, reflecting acquisition and maintenance costs, after depreciation and tax effects, is:

The salvage value of the copiers is $7,000, $5,500 and $2,000 at the end of the first, second and third years respectively. If the required return is 10% p.a., how frequently should the copiers be replaced?