Reference no: EM132858507

Question 1 - A new furnace for your small factory is being installed right now, will cost $37,000, and will be completed in one year. At that point, it will require ongoing maintenance expenditures of $2,500 a year. But it is far more fuel-efficient than your old furnace and will reduce your consumption of heating oil by 3,400 gallons per year. Heating oil this year costs $3 a gallon; the price per gallon is expected to increase by $0.50 a year for the next 3 years and then to stabilize for the foreseeable future. The furnace will last for 20 years from initial use, at which point it will need to be replaced and will have no salvage value. (Specifically, the firm pays for the furnace at time 0, and then reaps higher net cash flows from that investment at the end of years 1 - 20.). The discount rate is 8%.

Required -

a. What is the net present value of the investment in the furnace?

b. What is the IRR?

c. What is the payback period?

d. What is the equivalent annual cost of the furnace?

e. What is the equivalent annual savings derived from the furnace?

f. Compare the PV of the difference between the equivalent annual cost and savings to your answer to part (a). Are the two measures the same or is one larger?

Question 2 - Johnny's Lunches is considering purchasing a new, energy-efficient grill. The grill will cost $32,000 and will be depreciated straight-line over 3 years. It will be sold for scrap metal after 5 years for $8,000. The grill will have no effect on revenues but will save Johnny's $16,000 in energy expenses. The tax rate is 30%.

Required -

a. What are the operating cash flows in each year?

b. What are the total cash flows in each year?

c. Assuming the discount rate is 12%, calculate the net present value (NPV) of the cash flow stream. Should the grill be purchased?