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# ECF5220 Principles of Finance – Final Exam 1/11  Suggested Answers

Note these are brief solutions only. For theory questions a fuller coverage would be required in an exam

 Question 1 Tax rate 30% After-tax RRoR 15% Year 0 1 2 3 (‘000) (‘000) (‘000) (‘000) Sell old machinery \$850.0 Tax shield on disposal loss \$15.0 Cost of new machinery -\$1,200.0 Investment allowance tax savings \$90.0 After-tax redundancy payment -\$28.0 After-tax cost savings: Labour costs \$84.0 \$84.0 \$84.0 On-costs \$16.8 \$16.8 \$16.8 Depreciation tax savings: Old machinery -\$90.0 -\$90.0 -\$90.0 New machinery \$118.8 \$162.0 \$54.0 Sale of new machinery \$0.0 Tax shield on disposal loss \$25.2 Net Cash Flows -\$273.0 \$129.6 \$172.8 \$90.0 NPV @ 15% \$29.53 IRR 21.72%

Decision: The NPV is positive - purchase the new machinery.

Assumptions:

1)  All cash flows received at the end of the year

2)  Company is profitable and tax paid at the end of the year

3)  After-tax revenues (\$560,000) and after-tax factory and labour costs (\$112,000) are not incremental cash flows.

 Question 2 (A) Glasswork Ltd. Mortgage loan: PV = -\$1,000,000 n = 15 i = 9% PMT = \$124,058.83 PMT = -\$124,058.83 n =15 i = 8% PV = \$1,061,878.91

After-tax cost = 8.% (1 - 0.3) = 5.6%

Debentures:

PMT = -12%x\$100/4           i = 2.5%

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