CHAPTER 8

Solutions to Chapter-End Problems

8.1 As of June 2004:

(a) Class 10 (or a separate class, as per endnote for computer software),
30%
(b) Class 10 [as in part (a)], 30%
(c) Class 8, 20%
(d) Class 38, 30%
(e) Cash register: class 8, rate 20%, scanner, class 12, 100%

8.2 Using: MARRafter-tax ≅ MARRbefore-tax × (1 – t):

(a) MARRafter-tax ≅ 0.14 × (1 – 0.4) = 0.084 = 8.4%

(b) MARRafter-tax ≅ 0.14 × (1 – 0.5) = 0.074 = 7.0%
(c) MARRafter-tax ≅ 0.14 × (1 – 0.6) = 0.056 = 5.6%

8.3 Using: MARRafter-tax ≅ MARRbefore-tax × (1 – t)

0.052 ≅ MARRbefore-tax × (1 – 0.53)

MARRbefore-tax ≅ 0.052/0.47 = 11.06%

Similarly, using: IRRafter-tax ≅ IRRbefore-tax × (1 – t)

0.087 ≅ IRRbefore-tax × (1 – 0.53)

IRRbefore-tax ≅ 0.087/0.47 = 18.51%

Enrique will likely report a before-tax IRR of 18.5 % compared to a before-

tax MARR of 11%.

8.4 First year CCA is on $100 000 (all of capital purchases).

Net income
= 110 000 – 65 000 – 100 000(0.2) = 45 000 – 20 000 = $25 000

Taxes paid = 25 000×0.55 = $13 750

8.5 First year CCA is on $50 000 (half of capital purchases).

Net income
= 110 000 – 65 000 – 50 000(0.2) = 45 000 – 10 000 = $35 000

Taxes paid = 35 000×0.55 = $19 250

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8.6 P = –55 000(CCTFnew) + 17 000(P/A, 10%, 6)(1 – 0.54)

+ 1000(P/F, 10%, 6)(CCTFold)

CCTFnew = 1 – [(0.54)(0.2)(1 + 0.1/2)]/[(0.1 + 0.2)(1 + 0.1)] = 0.6564

CCTFold = 1 – (0.54×0.2)/(0.1 + 0.2) = 0.64

P = –55 000(0.6564) + 17 000(4.3552)(0.46) + 1000(0.56448)(0.64)

= –1 683

The after tax present worth of the chip placer is –$1683.

8.7 Before-tax IRR:

–400 000 + 85 000(P/A, i, 10) = 0
(P/A, i, 10) = 400 000/85 000 = 4.71

(P/A, 15%, 10) = 5.0187

(P/A, 20%, 10) = 4.1924

By interpolating: IRR = 16.9%

After-tax IRR = 16.9(1 – 0.45) = 9.3%

Quebec Widgets should not invest.

8.8 The CCTFnew is 1 – [(0.45)(0.2)(1 + i*/2)]/[(i* + 0.2)(1 + i*)].

Setting disbursements equal to receipts gives:

400 000(CCTFnew) = 85 000(P/A, i*, 10)(1 – 0.45)

Trial and error calculations give: i* = 10.1087%

The exact IRR is 10.1087%. Canadian Widgest should not invest.

8.9 The UCC at the end of 2000 was $26 779.

Year Adjustment Base UCC CCA@30% Remaining UCC

2004 10000
2005 50000 35000 10500 49500
2006 0 49500 14850 34650
2007 20000 44650 13395 41255
2008 -3000 38255 11477 26779

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8.10
1 2 3 4 5 6 7 8 9 10 11
Class UCC at Cost of Adjustments Proceeds UCC 50% Reduced CCA CCA UCC at
Number beginning acquisitions of (2)+(3)-(5) rule UCC Rate (8)*(9) year end
of year during Dispositions (6)-(7) (6)-(10)+(7)
(Col 11 from the year
last year)
a) 10 10000 30000 0 0 40000 15000 25000 0.3 7500 32500
b) 10 10000 20000 0 5000 25000 10000 15000 0.3 4500 20500
c) 8 20000 30000 0 15000 35000 15000 20000 0.2 4000 31000

8.11 The UCC account values are shown in the following spreadsheet.

Year Adjustment Base UCC CCA@20% Remaining UCC

1983 0
1984 200 000 100 000 20 000 180 000
1985 0 180 000 36 000 144 000
1986 0 144 000 28 800 115 200
1987 240 000 235 200 47 040 308 160
1988 0 308 160 61 632 246 528
1989 0 246 528 49 306 197 222
1990 0 197 222 39 444 157 778
1991 60 000 187 778 37 556 180 222
1992 0 180 222 36 044 144 178
1993 0 144 178 28 836 115 342
1994 0 115 342 23 068 92 274
1995 0 92 274 18 455 73 819
1996 345 000 246 319 49 264 369 555
1997 -45 000 324 555 64 911 259 644
1998 0 259 644 51 929 207 715

It can be seen that the depreciation for this CCA class for 1998 is $51 929.

8.12 (a) CCTFold = 1 – (0.5×0.2)/(0.09 + 0.2) = 0.6552

CCTFnew = 1 – [(0.5)(0.2)(1 + 0.09/2)]/[(0.09 + 0.2)(1 + 0.09)] = 0.6694

(b) CCTFold = 1 – (0.35×0.3)/(0.12 + 0.3) = 0.75

CCTFnew = 1 – [(0.35)(0.3)(1 + 0.12/2)]/[(0.12 + 0.3)(1 + 0.12)] =
0.7674

(c) CCTFold = 1 – (0.55×0.05)/(0.06 + 0.05) = 0.75

CCTFnew = 1 – [(0.55)(0.05)(1 + 0.06/2)]/[(0.06 + 0.05)(1 + 0.06)]
= 0.7571

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8.13 The following spreadsheet shows the numbers used for the chart, and the
chart:
Interest Rate CCTFold CCTFnew
0 0.5000 0.5000
0.05 0.6000 0.6095
0.1 0.6667 0.6818
0.15 0.7143 0.7329
0.2 0.7500 0.7708
0.25 0.7778 0.8000
0.3 0.8000 0.8231
0.35 0.8182 0.8418
0.4 0.8333 0.8571
0.45 0.8462 0.8700
0.5 0.8571 0.8810
0.55 0.8667 0.8903
0.6 0.8750 0.8984
0.65 0.8824 0.9055
0.7 0.8889 0.9118
0.75 0.8947 0.9173
0.8 0.9000 0.9222
0.85 0.9048 0.9266
0.9 0.9091 0.9306
0.95 0.9130 0.9342
1 0.9167 0.9375

1.0000
CCTFnew
0.9000
CCTF value

CCTFold
0.8000

0.7000

0.6000

0.5000
0 0.2 0.4 0.6 0.8 1
Interest rate

8.14 Before-tax IRR:

5000(P/F, i, 1) + 10 000(P/F, i, 2) – 12 000 = 0

At i = 0.14: LHS = 80.64

At i = 0.15: LHS = –90.73

Interpolation: IRR = 14.47%

Approximate after-tax IRR = 0.1447(1 – 0.4) = 0.0868

The after-tax IRR is approximately 8.68%.

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8.15 The CCTFnew is 1 – [(0.40)(0.3)(1 + i*/2)]/[(i* + 0.3)(1 + i*)].

Setting disbursements equal to receipts gives:

12 000(CCTFnew) = [5000(P/F, i*, 1) + 10 000 (P/F, i*, 2)](1 – 0.40)

Trial and error calculations give: i* = 6.226%

If the analysis had been done in 1975, we would use the old CCTF. The
CCTFold is 1 – (0.40)(0.3)/(i* + 0.3).

Setting disbursements equal to receipts gives:

12 000(CCTFold) = [5000(P/F, i*, 1) + 10 000(P/F, i*, 2)](1 – 0.40)

Trial and error calculations give: i* = 6.724%

8.16 t = 0.40, i = 0.20, d = 0.3

CCTFold = 1 – (0.4×0.3)/(0.2 + 0.3) = 0.76

CCFTnew = 1 – (0.4×0.3×1.1)/(1 + 0.2)(0.2 + 0.3) = 0.78

AW = –45 000(A/P, 20%, 5)CCTFnew + 4500(A/F, 20%, 5)CCTFold

– 0.22(750)(250)(1 – 0.4)
= –45 000(0.33438)(0.78) + 4500(0.13438)(0.76)
– 0.22(750)(250)(1 – 0.4)
= –36 072

The machine has a total annual cost of about $36 072.

8.17 d = 0.30, t = 0.40

Ordered by first cost, the alternatives are:

1) Free machine, first cost $6 000

2) Used machine, first cost = $36 000
3) Owned machine, first cost = $71 000

Alternative 1:

Note that the first cost is an expense of installation, and not a capital cost,
so the after-tax IRR is found by solving for i in:

6000(1 – t) = (20 000 – 15 000)(P/A, i, 6)(1 – t)

(P/A, i, 6) = 1.2

Noting that (P/A, 40%, 6) = 2.16 and (P/A, 50%, 6) = 1.8, the free machine
is acceptable as it has an after-tax IRR of above 50%.

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Next, look at the increment of investment between the free and used
machines:

Year Increment: used – free

0 –30000
1 12000
2 9500
3 7000
4 4500
5 2000
6 –500

This is almost a simple investment, so as an approximation, we will use an

IRR approach (the negative cash flow in the sixth year is not likely to
create multiple IRRs).

Taking present worths gives:

–30 000(CCTFnew) + PW(incremental annual flows)(1 – t) = 0

With a trial and error approach, we obtain an after-tax IRR of 3.18%,

which is below the MARR.

We now find the after-tax IRR on the incremental investment from the free
machine to the new machine.

Year Increment: new – free

0 –65000
1 15000
2 15000
3 15000
4 15000
5 15000
6 25000

This is a simple investment, so the IRR can be found as follows:

–65 000CCTFnew + PW(incremental cash flows)(1 – t)
+ (salvage value)CCTFold = 0

By trial and error we get an after-tax IRR of 9.88% that is less than the
MARR.

Conclusion: the free machine is best.

8.18 (a) DC(1) = (360 000 – 0)/10 = 36 000

Taxes = [1 600 000 – (1 300 000 + 36 000)]×0.5 = 132 000

They would pay about $132 000.

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(b) DC(1) =(360 000 – 0)/5 = 72 000

Taxes = [1 600 000 – (1 300 000 + 72 000)]×0.5 = 114 000

They would pay about $114 000.

(c) DC(1) = 360 000×0.2 = 72 000

Taxes = [1 600 000 – (1 300 000 + 72 000)]×0.5 = 114 000

They would pay about $114 000.

(d) DC(1) = 360 000×0.4 = 144 000

Taxes = [1 600 000 – (1 300 000 + 144 000)]×0.5 = 78 000

They would pay about $78 000.

(e) DC = 360 000

Taxes = [1 600 000 – (1 300 000 + 360 000)]×0.5 = –30 000

They would pay no taxes, and would have a tax credit of $30 000.

8.19 The value of the 30% UCC account at the end of 1979 was about
$10 242.
Year Adjustment Base UCC CCA@30% Remaining UCC
1971 0
1972 25000 25000 7500 17500
1973 0 17500 5250 12250
1974 14000 26250 7875 18375
1975 0 18375 5513 12863
1976 0 12863 3859 9004
1977 28000 37004 11101 25903
1978 -5000 20903 6271 14632
1979 0 14632 4390 10242

8.20 The value of the 30% UCC account at the end of 1989 was about
$12 962.
Year Adjustment Base UCC CCA@30% Remaining UCC
1981 0
1982 25000 12500 3750 21250
1983 0 21250 6375 14875
1984 14000 21875 6563 22313
1985 0 22313 6694 15619
1986 0 15619 4686 10933
1987 28000 24933 7480 31453
1988 -5000 26453 7936 18517
1989 0 18517 5555 12962

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8.21 CCFTnew = 1 – [(0.35)(0.2)(1 + 0.06/2)]/[(0.06 + 0.2)(1 + 0.06)] = 0.7384

PW = 380 000(CCFTnew) = 380 000(0.7384) = 280 588

The present worth of the crane, taking into account all future tax benefits
due to CCA, is $280 588.

8.22 CCFTnew = 1 – [(0.45)(0.2)(1 + 0.08/2)]/[(0.08 + 0.2)(1 + 0.08)] = 0.6905

CCTFold = 1 – (0.45×0.2)/(0.08 + 0.2) = 0.6786

First cost
= –230 000(CCTFnew) = –230 000(0.6905) = –158 810

Savings
= 35 000(P/A, 8%, 12)(1 – 0.45) = 35 000(7.5361)(0.55) = 145 070

Salvage value
= 30 000(P/F, 8%, 12)CCTFold = 30 000(0.39711)(0.6786) = 8084

PW = –158 810 + 145 070 + 8084 = –5656

The project has a present worth of –$5656; it should not be done.

8.23 CCFTnew = 1 – [(0.35)(0.3)(1 + 0.12/2)]/[(0.12 + 0.3)(1 + 0.12)] = 0.763

CCTFold = 1 – (0.35×0.3)/(0.12 + 0.3) = 0.75

First cost
= –65 000(A/P, 12%, 5)CCTFnew = –65 000(0.27741)(0.763) = –13 758

Annual savings = 15 000(1 – 0.35) = 9750

Salvage value
= 20 000(A/F, 12%, 5)CCTFold = 20 000(0.15741)(0.75) = 2361

Annual worth = –13 758 + 9750 + 2361 = –1647

The purchase will result in an annual cost of $1647 over five years.

8.24 Setting disbursements equal to receipts gives:

17 000(CCTFnew) = 3000(P/A, i, 7)(1 – 0.40) + 1000(P/F, i,7)CCTFold

This expression is solvable for i, but it is quite difficult since i appears in

the compound interest factors as well as in both CCTFs.

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An easier way is to use an after-tax MARR with an after-tax IRR:

IRRafter-tax ≅ IRRbefore-tax × (1 – t)

This works because the IRR is the percentage profit; taxes reduce profits.
It tends to over-estimate the IRR because it assumes that all CCA occurs
in the year of purchase. The errors are greater the higher the interest rate.

For this problem, a before-tax MARR is given; the after-tax MARR, by the
same reasoning, can be estimated as:

MARRafter-tax ≅ MARRbefore-tax × (1 – t) = 0.10(1 – 0.4) = 0.06

The MARRafter-tax can be estimated as about 6%. Note that the MARRafter-
tax is usually established from basic principles and not derived from the
MARRbefore-tax.

To answer this question, first find the IRRbefore-tax from:

17 000 = 3000(P/A, i, 7) + 1000(P/F, i, 7)
3(P/A, i, 7) + (P/F, i, 7) = 17

At i = 6%: LHS = 3(5.5824) + 0.66506 = 17.412

At i = 7%: LHS = 3(5.3893) + 0.62275 = 16.790

Linearly interpolating:
i = 6 + (17.412 – 17)/(17.412 – 16.790)= 6.662% = IRRbefore-tax

IRRafter-tax ≅ 0.06662(1 – 0.4) = 0.0400 = 4%

The after-tax IRR of 4% is less than the after-tax MARR, and the purchase
should not be made.

Note that the same conclusion could have been made in this case from
the IRRbefore-tax and the MARRbefore-tax. This justifies the common practice of
not considering taxes explicitly when doing IRR calculations.

8.25 The CCTFnew is 1 – [(0.40)(0.2)(1 + i*/2)]/[(i* + 0.2)(1 + i*)]

Setting disbursements equal to receipts gives:

17 000(CCTFnew) = [3000(P/A, i*, 7) + 1000 (P/F, i*, 7)](1 – 0.40)

Trial and error calculations gives: i* = 3.737%

Their exact after-tax IRR is 3.737%.

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The estimated after-tax MARR is: MARRafter-tax ≅ 0.1 × (1 – 0.4) = 6.0%

The purchase should not be made since the after-tax IRR is less than the
after-tax MARR.

8.26 CCFTnew = 1 – [(0.45)(0.2)(1 + 0.1/2)]/[(0.1 + 0.2)(1 + 0.1)] = 0.7136

CCTFold = 1 – (0.45×0.2)/(0.1 + 0.2) = 0.7

AW = –200 000(A/P, 10%, 20)CCTFnew

– [7500 + 25 000(A/P, 10%, 5)](1 – 0.45)
+ 15 000(A/F, 10%, 20)CCTFold
= –200 000(0.117 46)(0.7136)
– [7500 + 25 000(0.26380)](0.55) + 15 000(0.01746)(0.7)
= –$24 333

The after-tax annual cost of the slitter is –$24 333.

8.27 The present worth of a year’s savings due to CCA for the assets if they
were correctly recognised as Class 8 can be calculated using the
CCTFnew.

CCFTnew = 1 – [(0.5)(0.2)(1 + 0.09/2)]/[(0.09 + 0.2)(1 + 0.09)] = 0.6694

PWsavings-8 = 10 000 – 10 000(CCTFnew) = 10 000 – 10 000(0.6694) = 3306

The present worth of a year’s savings due to CCA for the items
recognised as Class 12 can be calculated directly from the tax rate:

PWsavings-12 = (10 000/2)(P/F, 9%, 1) = 5000(0.91743) = 4587

The present worth of the loss per year is then

PWloss = 4587 – 3306 = 1281

The present worth today of such losses over the past three years is then:

PW = 1281(F/A, 9%, 3) = 1281(3.2781) = 4199

The present worth of the cost today of this mistake is about $4199.

8.28 (a) Class 12, fully expensed in first year

(b) Class 1, 3 or 6, rate 5% to 10%
(c) Class 10, rate 30%
(d) Class 8, rate 20%
(e) Class 9, rate 25%
(f) Class 8, rate 20%

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8.29 As shown in the spreadsheet below, the contribution to the UCC for Class
8 at the end of 1991 was $10 737 for A and $12080 for B.
Book value
Machine Machine
Year A B
1981 100000 50000
1982 80000 90000
1983 64000 72000
1984 51200 57600
1985 40960 46080
1986 32768 36864
1987 26214 29491
1988 20972 23593
1989 16777 18874
1990 13422 15099
1991 10737 12080

8.30 CCFTnew = 1 – [(0.45)(0.2)(1 + 0.09/2)]/[(0.09 + 0.2)(1 + 0.09)] = 0.7025

CCTFold = 1 – (0.45×0.2)/(0.09 + 0.2) = 0.6897

The annual cost of the chemical recovery system is then:

A = –30 000(A/P, 9%, 7)CCTFnew + 5280(1 – 0.45)

+ 7500(A/F, 9%, 7)CCTFold
= –30 000(0.19869)(0.7025) + 5280(0.55) + 7500(0.10869)(0.6897)
= –721

The chemical recovery system has an after-tax annual cost of about $721.

8.31 CCFTnew = 1 – [(0.45)(0.05)(1 + 0.15/2)]/[(0.15 + 0.05)(1 + 0.15)] = 0.8948

Alternative 1:

Using the capitalized value formula:

A(first cost) = Pi(CCFTnew) = 2 000 000(0.15)(0.8948) = 268 440

A(maintenance) = 10 000(1 – 0.45) = 5500

A(paint)
= 15 000(A/F, 15%, 15)(1 – 0.45)= 15 000(0.02102)(0.55) = 173.42

A(total) = 274 113

Alternative 2:

A(first costs)
= 1 250 000(0.15)(0.8948) + 1 000 000(P/F, 15%, 10)(0.15)(0.8948)

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= 167 775 + 150 000(0.24719)(0.8948) = 200 953

The first 10 years incur maintenance costs of $5000 per year; convert to a
PW and spread over infinite life:

A(maintenance first 10 years)

= 5000(P/A, 15%, 10)(0.15)(1 – 0.45)
= 5000(5.0187)(0.15)(0.55)
= 2070.21

The maintenance costs change after the renovation to be $11 000 every
year. First convert this to a PW at the end of 10 years, then to PW now,
then spread over infinite life:

P(maintenance after 10 years)

= A/i(1 – t) = 11 000/(0.15)(1 – 0.45) = 40 333.33

P(maintenance after 10 years, now)

= 40 333.33(P/F, 15%, 10) = 40 333.33(0.2472) = 9970.40

A = P(maintenance after 10 years)(0.15) = 9970.40(0.15) = 1496

Painting costs are every 15 years, starting in 10 years. First calculate the
P(paint in 10 years), convert to P(now) and then to A(now):

P(paint in 10 years)
= A/i(1 – t) = 15 000(A/F, 15%, 15)/(0.15)(1 – 0.45)
= 15 000(0.02102)/(0.15)(0.55)
= 1156

P(paint now) = 1156(P/F, 15%, 10) = 1156(0.24719) = 285.64

A = P(paint now)(0.15) = 42.85

A(total) = 200 953+ 2070.21+ 1496+ 43 = 204 562

The annual cost of alternative 2 ($204 562) is less than that of alternative
1 ($274 113). Hence, select alternative 2.

8.32 t =0.52, d = 0.2, i = 0.11

CCTFnew = 1 – [(0.52)(0.2)(1 + 0.11/2)]/[(0.11 + 0.2)(1 + 0.11)] = 0.6811

CCTFold = 1 – (0.52×0.2)/(0.11 + 0.2) = 0.6645

By assuming that you can purchase each alternative as many times as

necessary, we can construct new projects:

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T': buy model T three times, total life 15 years

A': buy model A three times, total life 15 years
X': buy model X five times, total life 15 years

PT' = –100 000(0.6811)[1 + (P/F, 11%, 5) + (P/F, 11%, 10)]

+ 50 000(1 – 0.52)(P/A, 11%, 15)
+ 20 000(0.6645)[(P/F, 11%, 5) + (P/F, 11%, 10) + (P/F, 11%, 15)]
= –100 000(0.6811)(1 + 0.59345 + 0.35218) + 50 000(0.48)(7.1909)
+ 20 000(0.6645)(0.59345 + 0.35218 + 0.20900)
= 55 410

PA' = –150 000(0.6811)[1 + (P/F, 11%, 5) + (P/F, 11%, 10)]

+ 60 000(1 – 0.52)(P/A, 11%, 15)
+ 30 000(0.6645)[(P/F, 11%, 5) + (P/F, 11%, 10) + (P/F, 11%, 15)]
= –150 000(0.6811)(1 + 0.59345 + 0.35218) + 60 000(0.48)(7.1909)
+ 30 000(0.6645)(0.59345 + 0.35218 + 0.20900)
= 31 340

PX' = –200 000(0.6811)[1 + (P/F, 11%, 3) + (P/F, 11%, 6)

+ (P/F, 11%, 9) + (P/F, 11%, 12)] + 75 000(1 – 0.52)(P/A, 11% 15)
+ 100 000(0.6645)[(P/F, 11%, 3) + (P/F, 11%, 6)
+ (P/F, 11%, 9) + (P/F, 11%, 12) + (P/F, 11%, 15)]
= –200 000(0.6811)(1 + 0.73119 + 0.53464 + 0.39092 + 0.28584)
+ 75 000(0.48)(7.1909) + 100 000(0.6645)(0.73119 + 0.53464
+ 0.39092 + 0.28584 + 0.20900)
= 1006

Model T is the best choice because it has the highest present worth.

8.33 t = 0.52, d = 0.2, i = 0.11

CCTFnew = 1 – [(0.52)(0.2)(1 + 0.11/2)]/[(0.11 + 0.2)(1 + 0.11)] = 0.6811

CCTFold = 1 – (0.52×0.2)/(0.11 + 0.2) = 0.6645

PT = –100 000(0.6811) + 50 000(1 – 0.52)(P/A, 11%, 3)

+ 40 000(0.6645)(P/F, 11%, 3)
= –100 000(0.6811) + 50 000(0.48)(2.4437)
+ 40 000(0.6645)(0.73119)
= 9974

PA = –150 000(0.6811) + 60 000(1 – 0.52)(P/A, 11%, 3)

+ 80 000(0.6645)(P/F, 11%, 3)
= –150 000(0.6811) + 60 000(0.48)(2.4437)
+ 80 000(0.6645)((0.73119)
= 7084

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PX = –200 000(0.6811) + 75 000(1 – 0.52)(P/A, 11%, 3)

+ 100 000(0.6645)(P/F, 11%, 3)
= –200 000(0.6811) + 75 000(0.48)(2.4437)
+ 100 000(0.6645)(0.73119)
= 341

Model T is the best choice because it has the highest present worth.

8.34 AWT = –100 000(0.6811)(A/P, 11%, 5) + 50 000(1 – 0.52)

+ 20 000(0.6645)(A/F, 11%, 5)
= –100 000(0.6811)(0.27057) + 50 000(0.48)
+ 20 000(0.6645)(0.16057)
= 7705

AWA = –150 000(0.6811)(A/P, 11%, 5) + 60 000(1 – 0.52)

+ 30 000(0.6645)(A/F, 11%, 5)
= –150 000(0.6811)(0.27057) + 60 000(0.48)
+ 30 000(0.6645)(0.16057)
= 4358

AWX = –200 000(0.6811)(A/P, 11%, 3) + 75 000(1 – 0.52)

+ 100 000(0.6645)(A/F, 11%, 3)
= –200 000(0.6811)(0.40921)
+ 75 000(0.48) + 100 000(0.6645)(0.29921)
= 140

Model T is the best choice because it has the highest annual worth.

8.35 First find the before-tax IRR for each model:

–100 000 + 50 000(P/A, i%, 5) + 20 000(P/F, i%, 5) = 0
⇒ IRRT-before-tax = 43.11%

i= 42% 43% 43.11% 44% 45%

(P/A,i%,5) = 1.9686 1.9367 1.9334 1.9057 1.8755
(P/F, i%,5) = 0.1732 0.1672 0.1666 0.1615 0.1560
PW(disbursements) = -100000 -100000 -100000 -100000 -100000
PW(receipts) = 101892 100178 100000 98514 96897
PW(total) = 1892 178 0 -1486 -3103

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–150 000 + 60 000(P/A, i%, 5) + 30 000(P/F, i%, 5) = 0

⇒ IRRA-before-tax = 31.39%

i= 30% 31% 31.39% 32% 33%

(P/A,i%,5) = 2.4356 2.3897 2.3723 2.3452 2.3021
(P/F, i%,5) = 0.2693 0.2592 0.2554 0.2495 0.2403
PW(disbursements) = -150000 -150000 -150000 -150000 -150000
PW(receipts) = 154214 151156 150000 148198 145337
PW(total) = 4214 1156 0 -1802 -4663

–200 000 + 75 000(P/A, i%, 3) + 100 000(P/F, i%, 3) = 0

⇒ IRRX-before-tax = 24.30%

i= 23% 24% 24.30% 25% 26%

(P/A,i%,3) = 2.0114 1.9813 1.9724 1.9520 1.9234
(P/F, i%,3) = 0.5374 0.5245 0.5207 0.5120 0.4999
PW(disbursements) = -200000 -200000 -200000 -200000 -200000
PW(receipts) = 204591 201046 200000 197600 194248
PW(total) = 4591 1046 0 -2400 -5752

Then calculate the approximate after-tax IRR:

IRRT-after-tax ≅ IRRT-before-tax × (1 – 0.52) = 0.4311(0.48) = 0.2069 = 20.69%

IRRA-after-tax ≅ IRRA-before-tax × (1 – 0.52) = 0.3139(0.48) = 0.1507 = 15.07%
IRRX-after-tax ≅ IRRX-before-tax × (1 – 0.52) = 0.2430(0.48) = 0.1167 = 11.67%

8.36 Using trial and error in a spreadsheet program results in:

IRRT-after-tax = 20.64%

i= 19% 20% 20.64% 21% 22%

CCTF(old) = 0.7333 0.7400 0.7441 0.7463 0.7524
CCTF(new ) = 0.7546 0.7617 0.7660 0.7684 0.7747
(P/A,i%,5) = 3.0576 2.9906 2.9490 2.9260 2.8636
(P/F, i%,5) = 0.4190 0.4019 0.3913 0.3855 0.3700
PW(disbursements) = -75462 -76167 -76599 -76835 -77471
PW(receipts) = 79529 77722 76599 75979 74295
PW(total) = 4067 1556 0 -857 -3176

IRRA-after-tax = 14.67%

i= 13% 14% 14.67% 15% 16%

CCTF(old) = 0.6848 0.6941 0.7001 0.7029 0.7111
CCTF(new ) = 0.7030 0.7129 0.7192 0.7222 0.7310
(P/A,i%,5) = 3.5172 3.4331 3.3783 3.3522 3.2743
(P/F, i%,5) = 0.5428 0.5194 0.5043 0.4972 0.4761
PW(disbursements) = -105447 -106935 -107886 -108335 -109655
PW(receipts) = 112448 109688 107886 107025 104457
PW(total) = 7001 2753 0 -1310 -5198

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IRRX-after-tax = 11.08%

i= 10% 11% 11.08% 12% 13%

CCTF(old) = 0.6533 0.6645 0.6653 0.6750 0.6848
CCTF(new ) = 0.6691 0.6811 0.6820 0.6924 0.7030
(P/A,i%,3) = 2.4869 2.4437 2.4405 2.4018 2.3612
(P/F, i%,3) = 0.7513 0.7312 0.7297 0.7118 0.6931
PW(disbursements) = -133818 -136228 -136406 -138482 -140595
PW(receipts) = 138613 136563 136406 134511 132465
PW(total) = 4794 335 0 -3971 -8130

8.37 First calculate the before-tax IRR of the alternative with the cheapest first
cost, T.
–100 000 + 50 000(P/A, i%, 5) + 20 000(P/F, i%, 5) = 0
⇒ IRRT-before-tax = 43.11%

i= 42% 43% 43.11% 44% 45%

(P/A,i%,5) = 1.9686 1.9367 1.9334 1.9057 1.8755
(P/F, i%,5) = 0.1732 0.1672 0.1666 0.1615 0.1560
PW(disbursements) = -100000 -100000 -100000 -100000 -100000
PW(receipts) = 101892 100178 100000 98514 96897
PW(total) = 1892 178 0 -1486 -3103

Then calculate the after-tax IRR:

IRRT-after-tax ≅ IRRT-before-tax × (1 – 0.52) = 0.4311(0.48) = 0.2069 = 20.69%

This is higher than the after-tax MARR, so that alternative T is acceptable.

Next check the before-tax IRR of the increment of investment from T to A:

[–150 000 – (–100 000)] + (60 000 – 50 000)(P/A, i%, 5)

+ (30 000 – 20 000)(P/F, i%, 5) = 0
–50 000 + 10 000(P/A, i%, 5) + 10 000(P/F, i% 5) = 0
⇒ IRRA–T before-tax = 5.73%

i= 4% 5% 5.73% 6% 6%
(P/A,i%,5) = 4.4518 4.3295 4.2432 4.2124 4.2124
(P/F, i%,5) = 0.8219 0.7835 0.7568 0.7473 0.7473
PW(disbursements) = -50000 -50000 -50000 -50000 -50000
PW(receipts) = 52737 51130 50000 49596 49596
PW(total) = 2737 1130 0 -404 -404

Then calculate the after-tax IRR:

IRRA–T after-tax ≅ IRRA–T before-tax × (1 – 0.55) = 0.0573(0.45) = 0.0258 =

2.58%

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Alternative A is rejected because the after-tax IRR is less than the after-
tax MARR. We next look at the increment of investment from T to X. We
have to be careful since X has a duration of 3 years, while T has 5 years.
We could use a 15-year study period, or a 3-year study period using the
information from Problem 8.33, or look at the increment on an annual
basis. Using a 3-year study period:

[–200 000 – (–100 000)] + (75 000 – 50 000)(P/A, i%, 3)

+ (100 000 – 40 000)(P/F, i%, 3) = 0
–100 000 + 25 000(P/A, i%, 3) + 60 000(P/F, i% 3) = 0
⇒ IRRX–T before-tax = 13.29%

i= 12% 13% 13.29% 14% 15%

(P/A,i%,3) = 2.4018 2.3612 2.3495 2.3216 2.2832
(P/F, i%,3) = 0.7118 0.6931 0.6877 0.6750 0.6575
PW(disbursements) = -100000 -100000 -100000 -100000 -100000
PW(receipts) = 102753 100612 100000 98539 96532
PW(total) = 2753 612 0 -1461 -3468

Then calculate the after-tax IRR:

IRRX–T after-tax ≅ IRRX–T before-tax × (1 – 0.55) = 0.1329(0.45) = 0.0598 =

5.98%

Since the after-tax IRR of the incremental investment to X from T is less

than the MARR, Model T should be chosen.

8.38 d = 0.30, t = 0.40

Ordered by first cost, the alternatives are:

1) Free machine, first cost $6 000

2) Used machine, first cost = $36 000
3) Owned machine, first cost = $71 000

The incremental IRR from do-nothing to alternative 1:

6000 = (20 000 – 15 000)(P/A, i, 6)

(P/A, i, 6) = 1.2

Noting that (P/A, 40%, 6) = 2.16 and (P/A, 50%, 6) = 1.8, the free machine
has a before-tax IRR of greater than 50%. That is, the free machine has
an approximate after-tax IRR of greater than 50%×(1 – 0.4) = 30%. The
free machine is acceptable.

Next, look at the increment of investment between the free and used
machines:
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Year Increment: used – free

0 –30000
1 12000
2 9500
3 7000
4 4500
5 2000
6 –500

An ERR method was used since the incremental cash flows were not a
simple investment. From the result of Problem 5.9, the ERR was found to
be 8.78%. Then the approximate after-tax ERR is computed as
8.78%×(1 – 0.4) = 5.268% < MARR. The incremental investment between
the free and used machines is not warrented.

We now look at the increment of investment between the free and new
machines:

Year Increment: new – free

0 –65000
1 15000
2 15000
3 15000
4 15000
5 15000
6 25000

This is a simple investment. From the result of Problem 5.9, the IRR for
this incremental investment was found to be 12.88%. The approximate
after-tax IRR is then computed as 12.88%×(1 – 0.4) = 7.728% < MARR.
Hence, the new machine is not a good investment also.

Conclusion: the free machine is best.

8.39 The exact after-tax IRR is calculated by trial and error to be

IRRafter-tax = 8.44%.
i= 7% 8% 8.44% 9% 10%
CCTF(old) = 0.5926 0.6071 0.6133 0.6207 0.6333
CCTF(new ) = 0.6059 0.6217 0.6283 0.6363 0.6500
(P/A,i%,6) = 4.7665 4.6229 4.5612 4.4859 4.3553
(P/F, i%,6) = 0.6663 0.6302 0.6148 0.5963 0.5645
PW(disbursements) = -66651 -68386 -69117 -69998 -71500
PW(receipts) = 72246 70061 69117 67962 65946
PW(total) = 5595 1675 0 -2037 -5554

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The before-tax IRR is calculated to be IRRbefore-tax = 18.77%

i= 17% 18% 18.77% 19% 20%

(P/A,i%,6) = 3.5892 3.4976 3.4292 3.4098 3.3255
(P/F, i%,6) = 0.3898 0.3704 0.3562 0.3521 0.3349
PW(disbursements) = -110000 -110000 -110000 -110000 -110000
PW(receipts) = 115472 112337 110000 109336 106463
PW(total) = 5472 2337 0 -664 -3537

IRRafter-tax ≅ IRRbefore-tax × (1 – 0.55) = 0.1877(0.45) = 0.0845 = 8.45%

Since the IRR, through either calculation, is less than the MARR, the
backhoe should not be purchased.

Notes for Mini-Case 8.1

1)-3) Answers here will depend on recent changes to the tax rules.

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