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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...