N5-12 A large company must build a bridge to have access to land tor expansion o

Question

N5-12 A large company must build a bridge to have access to land tor expansion of its manufacturing plant. The bridge could be fabricated of normal steel for an initial cost of $30,000 and should last for 15 years. Maintenance will cost $1000 per year. If the steel used were more corrosion resistant, the annual maintenance cost would be only $100 per year, although the life would be the same. In 15 years there would be no salvage value for either bridge. The company pays combined federal and state taxes at the 42% marginal rate and uses straight-line depreciation. If the minimum attractive after-tax rate of return is 12%, what is the maximum amount that should be spent on the corrosion-resistant bridge? [ans] Supply answer with 2 decimal place precision as a positive number

Explanation / Answer

Operating cash flow for normal steel = (0-1000-30000/15)*(1-42%) + 30000/15= 260

NPV of normal steel= -30000 + 260*(1-1/1.12^15)/12%=-28229.18

Let maximum amount be x

Operating cash flow for corrosion resistant steel = (0-100-x/15)*(1-42%) + x/15 = -58 + x/15*42%

For maximum value spent, NPV should be equal

-28229.18 = -x + (-58 + x/15*42%)*(1-1/1.12^15)/12%

X= 34393.04

maximum amount = 34393.04

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