CE22 THU 2nd Problem Set

Due Date: September 3, 2009 (Thursday)

Good evening friends! It’s now time to apply what you have learned about time-money relationships. I hope
you’ll do better than your first exam. Think hard and use your analytical skills. Good luck and God bless! ☺

Instructions:
1. This exam has only 1 problem. You are tasked to choose from the given alternatives. However, the problem
is divided into four parts. Start each part on a separate sheet.
2. Write your name and problem number on each of your answer sheet.
3. Solutions written at the back of your papers will be considered as scratch and shall not be checked.
4. Assume end of the year cash flows for all problems.

Sy-Yi Tutu Co. is considering the purchase of a new machine to modernize its current production line. As one
of the best financial consultant in the Philippines, Sy-Yi Tutu Co. asked you to evaluate five types of machines
that are available in the market. As business grows to a certain level, Sy-Yi Tutu expects that none of the five
models may be able to handle the expanded volume at the end of year 20. Thus, you decided to use 20 years as
your analysis period. You gathered data about each machine and tabulated the necessary information:

Machine A Machine B Machine C Machine D Machine E

Investment 35,000 35,000 20,000 15,000 35,000
Annual Net Cash
5,000 5,000 5,000 5,000 9,000
Flow for years 1-10
Annual Net Cash
5,000 9,000 7,000 --- 5,000
Flow for years 11-15
Annual Net Cash
--- 9,000 7,000 --- 5,000
Flow for years 16-20
Annual Net Cash
--- --- 5,000 --- ---
Flow for years 21-25
Useful Life (years) 15 20 25 10 20
Salvage Value (end
10,000 7,000 5,000 2,000 7,000
of useful life)

You also assumed that of the five machines, only Machine D will be available in the future without significant
changes in price and costs. The MARR of Sy-Yi Tutu Co. is 15%.

I. According to Sy-Yi Tutu Co.’s policies, only projects with a payback period of 7 years or less should
be accepted. Thus, you decided to initially screen machines B, C and E using discounted payback
period. What can you conclude from this initial screening? Show your complete solution. (20 pts)

II. Since Machine A can only be used for 15 years, you have decided that in case Machine A is chosen,
Machine D will be purchased at the end of year 10 so satisfy Sy-Yi Tutu’s requirements for years 16-
20. Using this scheme, how much can Sy-Yi Tutu sell Machine D (purchased after the end of useful
life of Machine A) at EOY20? How much can Sy-Yi Tutu sell Machine C at EOY20? (20 pts)

III. Previous calculations reveal that the IRR of Machine B is 15.72% while that of Machine E is 24.29%.
Co-terminating the useful lives to 20 years, determine the acceptability of the other machines using
IRR. (30 pts)

IV. Using Incremental Investment Analysis (not necessarily IRR), determine the best alternative. (30 pts)

Bonus:
1. Why do you usually get inconsistent results when evaluating two or more mutually exclusive projects using
plain IRR method and discounted cash flow methods?
2. Why is it not advisable to use only payback period method when evaluating two or more mutually exclusive
alternatives?
3. How was your exam? What’s your favorite part? Do you think you deserve a bonus? =)