What are the implications for a firm's capital investment decisions of using a company-wide cost of capital
when the firm has multiple operating divisions that have unique risk attributes and capital costs?
What will be an ideal response?
Question 2
AFB Corp needs to replace an old lathe with a new, more efficient model. The old lathe was
purchased for 50,000 nine years ago and has a current book value of 5,000.
(The old machine is
being depreciated on a straight-line basis over a ten-year useful life.) The new lathe costs 100,000.
It will cost the company 10,000 to get the new lathe to the factory and get it installed. The old
machine will be sold as scrap metal for 2,000. The new machine is also being depreciated on a
straight-line basis over ten years. Sales are expected to increase by 8,000 per year while operating
expenses are expected to decrease by 12,000 per year. AFB's marginal tax rate is 40. Additional
working capital of 3,000 is required to maintain the new machine and higher sales level. The new
lathe is expected to be sold for 5,000 at the end of the project's ten-year life. What is the
incremental free cash flow during years 2 through 10 of the project?
A) 15,800 B) 14,400 C) 16,400 D) 13,600
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