- A telephone company is considering building a new automated switching distribution substation with a useful life of 20 years to support new suburban developments. The substation is located in a state in which the combined tax rate is 40%, and the telephone company uses a 15% real interest MARR to assess capital investment projects. Estimated real dollar revenues and costs are as follows:
| Category | Amount | |
| Building initial cost | $ | 1,157,000 |
| Building salvage cost | $ | 250,000 |
| Equipment initial cost | $ | 575,000 |
| Equipment salvage value | $ | 29,000 |
| Annual revenues | $ | 650,000 year 1 |
| Revenue arithmetic gradient | $ | 20,000 years 2 to 5 |
| Annual revenues | $ | 750,000 years 6 to 20 |
| Annual operating expenses | $ | 185,000 first 10 years |
| $ | 230,000, years 11 to 15 | |
| $ | 275,000, years 16 to 20 | |
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The substation will be put into service on the first day of the telephone company’s fiscal year. Using MACRS depreciation, what will be the telephone company’s after tax equivalent uniform annual worth for the substation?
- The research and development division of a large corporation is considering the purchase of a new tunneling X-ray microscope for $320,125. The projected net benefits from gains in materials engineering is projected to be $127,000 in today’s real dollars for the first year, increasing by an arithmetic gradient of $20,000 per year in real dollars for years 2 to 4. The unit will be depreciated under MACRS. Due to increasing advances in tunneling
X-ray microscope technology, the unit will have $60,000 market value in today’s real dollars at the end of the 4 year project life. During the 4 year analysis period, inflation is expected to be steady at 3.8% per year. The corporation has a combined state and federal income tax rate of 40.0%. The corporation requires a 20.0% after-tax market rate of return on its research and development investments. Should the X-ray unit be purchased?
ENMA 302, Engineering Economy Summer 2016 Final Examination
5.
Part 1
A firm has the current liabilities and equity financing on its balance sheet. The firm has taxable income that puts it in a 38% federal tax bracket, and the state in which it operates levies a 6.5% income tax. Compute the firm’s weighted average cost of capital.
| Source | Amount | Interest/RoR | Proportion | |
| Short-term loan | $ | 5,000,000 | 7.5% | 0.05 |
| Long-term loan | $ | 20,000,000 | 5.8% | 0.25 |
| Retained Earnings | $ | 25,000,000 | 17.0% | 0.20 |
| Common stock | $ | 50,000,000 | 22.0% | 0.50 |
Part 2
The same firm is considering the following projects to improve its production process. If the firm has a capital budget of $1,400,000, which projects should be accepted by the rate of return criteria? What is the firm’s opportunity cost of capital?
| Project | First Cost | Annual Benefit | Life (years) | |
| 1 | $ | 250,000 | $50,000 | 15 |
| 2 | $ | 300,000 | $70,000 | 10 |
| 3 | $ | 125,000 | $35,000 | 5 |
| 4 | $ | 50,000 | $12,500 | 10 |
| 5 | $ | 250,000 | $75,000 | 5 |
| 6 | $ | 200,000 | $32,000 | 20 |
| 7 | $ | 400,000 | $125,000 | 5 |
Part 3
From your estimates of the WACC in part 1 and the opportunity cost of capital in part 2, what do you estimate the firm’s true MARR to be?
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