The New Economy Transport Company Case

confirming pages

Chapter 6

In this case the effective rate equals the statutory rate.

a. Calculate T E for the guano project in Section 6.2.

b. How does the effective rate depend on the tax depreciation schedule? On the inflation

rate?

c. Consider a project where all of the up-front investment is treated as an expense for tax

purposes. For example, R&D and marketing outlays are always expensed in the United

States. They create no tax depreciation. What is the effective tax rate for such a project?

32. We warned that equivalent annual costs should be calculated in real terms. We did not

fully explain why. This problem will show you.

Look back to the cash flows for machines A and B (in “Choosing between Long- and

Short-Lived Equipment”). The present values of purchase and operating costs are 28.37

(over three years for A) and 21.00 (over two years for B). The real discount rate is 6% and

the inflation rate is 5%.

a. Calculate the three- and two-year level nominal annuities which have present values of

28.37 and 21.00. Explain why these annuities are not realistic estimates of equivalent

annual costs. (Hint: In real life machinery rentals increase with inflation.)

b. Suppose the inflation rate increases to 25%. The real interest rate stays at 6%. Recalculate the level nominal annuities. Note that the ranking of machines A and B appears to

change. Why?

33. In December 2005 Mid-American Energy brought online one of the largest wind farms in

the world. It cost an estimated $386 million and the 257 turbines have a total capacity of

360.5 megawatts (mW). Wind speeds fluctuate and most wind farms are expected to operate at an average of only 35% of their rated capacity. In this case, at an electricity price of

$55 per megawatt-hour (mWh), the project will produce revenues in the first year of $60.8

million (i.e., .35 8,760 hours 360.5 mW $55 per mWh). A reasonable estimate of

maintenance and other costs is about $18.9 million in the first year...