PRINCIPLES OF FINANCE
FIN 3403
Capital Budgeting: Cash Flow Estimation and Risk
1. The CFO of Genham Publishing Corporation is evaluating a proposal to purchase a new
printing machine that will help the firm to more efficiently produce the magazines it
publishes. If the new printer is purchased, it will replace an existing printer. The new
printer has a purchase price of $130,000. In addition, it costs $8,000 to ship the printer to
Genham, and $3,000 will have to be paid to modify existing facilities to install the printer.
Genham expects sales to increase by $40,000 if it purchases the new printer. Even though
sales will increase, raw materials, labor costs, and other operating expenses are not
expected to change if the new printer is purchased, because the new machine is more
efficient than the existing machine. These estimates were provided by a consultant
Genham hired a few months. The consultant was paid $10,000 to evaluate the new printer
and to estimate the effects on operations of replacing the existing printer. The estimated life
of the new printer is five years, which is the same as the estimated remaining life of the old
printer. In five years, it is estimated that the new printer can be sold for $20,000 and that
the old printer can be sold for $6,000 if the firm decides not to purchase the new printer.
The existing printer, which was purchased two years ago for $90,000, currently has a
market value equal to $18,000. Both the new printer and the existing printer fall in the
MACRS 5-year class for the purposes of determining depreciation. Genham’s required rate
of return is 15 percent and its marginal tax rate is 35 percent. Should Genham purchase the
new printer? Support your answer with computations. Compute both the net present value
(NPV) and the internal rate of return (IRR) for the project.
2. The CFO of Genham just learned that the new printer that is being evaluated is considered
a much riskier investment than its existing, or average, assets. Generally, when projects that
are considered much riskier than the “average” assets are evaluated, Genham adds three
percentage points to its required rate of return when computing the NPV. Based on this
new information, should Genham purchase the project?
SOLUTION
Initial Investment Outlay:
New printer purchase price (130,000)
Shipping ( 8,000)
Installation ( 3,000)
Sale of old printer 18,000
Tax on sale of old printer 8,820*
Initial investment outlay (114,180)
Book value of old asset = 90,000 - 90,000(0.20 + 0.32) = 43,200 (The asset is two years old and being
depreciated using MACRS 10-year life rates.)
