INEN 303: Engineering Economic Analysis

Spring 2006: Group Quiz III

The best 6 out of 8 will be graded (Group 1 must do all questions).

Remember: cash flow diagram, formulas, then answers!!!

1. An engineer, Juliet Capulet, at Anode metals is considering some projects, all of which can be considered to last indefinitely. Project A has a first cost of $20,000 and annual income of $3,000. Project B has a first cost of $10,000 and annual income of $2,000. Project C has a first cost of $15,000 and annual income of $2,800. If the MARR is 15% per year, determine which project should be selected.

2. Two routes are under consideration by the Wiz for a new segment to the yellow brick road. The long route would be 25 miles and would have an initial cost of $21 million. The short trans-mountain route through the purple hills would span 10 miles and would have an initial cost of $45 million. The yearly maintenance costs are estimated at $40,000 for the long route and $15,000 for the short route. Additionally, a major overhaul and resurfacing will be required every 10 years at a cost of 10% of the first cost of each route. Regardless of which route is selected, the volume of traffic is expected to be 400,000 travelers per year. If the traveler operating expense is assumed to be $0.35 per mile and the value of the reduced travel time for the short route is estimated at $900,000 per year, determine which route should be selected by the Wiz, using a B/C analysis. Assume an infinite life for each road, an interest rate of 6% per year, and that one of the roads will be built.

3. Brooks and Dunn Holdings Inc. wants to arrange for $50 million in capital for a new project. The current financing plan is 60% equity capital and 40% debt financing. Common stock sales that pay dividends at a rate of 5% per year will consist of 40% of the equity capital. The rest of the equity capital will come from retained earnings which currently earn 9% per year. The debt capital will come from two sources: bank loans for $10 million borrowed at 8% per year; and the remainder in convertible bonds at an estimated 10% per year bond interest rate. Compute the WACC for Brooks and Dunn Holdings Inc.

4. Shriners Children’s Hospital of Houston, which opened in 1952 and is a nonprofit organization, pays no taxes on income and receives no tax advantage for interest paid. The board of directors has approved expanding the play area that will require $10 million in debt capital to supplement $8 million in equity capital currently available. The $10 million can be borrowed at 7.5% per year through the Shriners Children’s Hospital Corporation. Alternatively, 30-year trust bonds could be issued through the hospital’s for-profit outpatient corporation, Shriners Outreach, Inc. The interest on the bonds is expected to be 9.75% per year, which is tax-deductible. The bonds will be sold at a 2.5% discount for rapid sale. The effective tax rate of Shriners Outreach is 32%. Which form of debt financing is less expensive after taxes?

5. Last year Roccawear purchased some U. S. Treasury bonds that return an average of 4% per year. Now, Euro bonds are being purchased with a realized average return of 3.9% per year. The volatility factor of Roccawear stock last year was 1.1 and has increased this year to 1.18. Other publicly traded stocks in the same business are paying an average of 5.1% dividends per year. Determine the cost of equity capital for each year.

6. An in-place machine for the McDowell’s restaurant has an equivalent annual worth of -$200,000 for each year of its maximum remaining useful life of 2 years. A suitable replacement is determined to have equivalent annual worth values of -$300,000, -$225,000, and -$275,000 per year, if kept for 1, 2, or 3 years, respectively. When should McDowell’s replace the machine, if it uses a fixed 3-year planning horizon? Use an interest rate of 9% per year.

7. King Jaffe Joffer is considering projects to help Zamunda’s infrastructure. Project 1 has an initial cost of $1.5 million, 8-year life, and annual revenue of $360,000. Project 1 has an initial cost of $1.5 million, 8-year life, and annual revenue of $360,000. Project 2 has an initial cost of $3 million, 10-year life, and annual revenue of $600,000. Project 3 has an initial cost of $1.8 million, 5-year life, and annual revenue of $520,000. Project 4 has an initial cost of $2 million, 4-year life, and annual revenue of $820,000. Which projects should King Joffer choose if he has a capital investment limit of $4 million and the MARR is 10%? Also, give an integer programming formulation for the problem.

8. The Dallas Cowboys are considering two sound systems for their new stadium. The first sound system costs $80 million and is expected to last 15 years. The second sound system costs $190 million and is expected to last 25 years. The first sound system has a maintenance cost of $30 million after every 200 hours of usage. The second system has a maintenance cost of $70 million after every 800 hours of usage. If the operating cost of each system is $1 per hour of usage, how many hours per year must the sound system be used to justify the purchase of the more expensive sound system? Use an interest rate of 10% per year.