Name ___________________________ A
CPE 522 – Engineering Economics
Exam 3
Tuesday, November 25, 2008
1. (65 points) Bowersock, Ltd. operates the dam on the Kansas River, just east of the
Massachusetts St. bridge. Their engineers propose a system to sell the water-
generated electricity to the regional power company, Westar. They will require
equipment and transmission lines to reach the nearby transformer station, and the
purchase of a small amount of land. The timing of investments and cash flows is shown
in Table 1 on the next page.
The land will be purchased for $50,000 in Year 0. The total investment (purchase of the
installed equipment and lines) is $500,000. One-half ($250,000) will be paid at the end
of Year 1 from company funds. The other half will be paid at the end of Year 2, but it
will be borrowed at an interest rate of 8%, compounded annually. This $250,000 loan
will be paid off in 3 equal payments, at the end of Years 3, 4 and 5.
The equipment part of the investment is classified as a 5-year property for purposes of
depreciation. Depreciation should start in Year 3, using the MACRS model. The
equipment does have a salvage value -- $30,000 – which should be treated as ordinary
income in Year 8.
At the end of the project life (Year 8), the land will be sold for $68,000. This is profit
(like the salvage) and should be treated like ordinary income. The $35,000 spent as
working capital in Year 2 is returned as a positive cash flow in Year 8, as well.
The federal income tax rate for this company is 35%. The numbers on the table take
into account a 4% inflation rate. That is, each year’s amounts are in ‘then current’
dollars.
If Bowersock must make a ‘real’ (constant dollar) internal rate of return (IRR) of
15%, should they do this project?
Show your calculations, assumptions and answer clearly on the next page, or reference
any other page you use.
