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CFA Institute CFA-Level-II Exam - Topic 3 Question 88 Discussion
Topic #: 3
Henke Malfoy, CFA, is an analyst with a major manufacturing firm. Currently, he is evaluating the replacement of some production equipment. The old machine is still functional and could continue to serve in its current capacity for three more years. Tf the new equipment is purchased, the old equipment (which is fully depreciated) can be sold for $50,000. The new equipment will cost $400,000, including shipping and installation. If the new equipment is purchased, the company's revenues will increase by $175,000 and costs by $25,000 for each year of the equipment's 3-year life. There is no expected change in net working capital.
The new machine will be depreciated using a 3-year MACRS schedule (note: the 3-year MACRS schedule is 33.0% in the first year, 45% in the second year, 15% in the third year, and 7% in the fourth year). At the end of the life of the new equipment (i.e., in three years), Malfoy expects that it can be sold for $10,000. The firm has a marginal tax rate of 40%, and the cost of capital on this project is 20%. In calculation of tax liabilities, Malfoy assumes that the firm is profitable, so any losses on this project can be offset against profits elsewhere in the firm. Malfoy calculates a project NPV of-$62,574.
What is the IRR based on Malfoy's NPV estimate, and should the project be accepted or rejected in order to maximize shareholder value?
IRR Project
Credit risk in a swap is generally highest in rhe middle of the swap. At the end of the swap there are few potential payments left and the probability of either party defaulting on their commitment is relatively low. Therefore, Widby's first comment is incorrect. It Jacobs wants to delay establishing a swap position, a swaption would potentially be an appropriate investment. However, Jacobs should buy a receiver swaption, not a payer swaption. In a payer swaption, Jacobs would pay the fixed-rate and receive the equity index return. The swap underlying a payer swaption would not offset Jacobs's current position. (Study Session 17, LOS 6l.f,i)
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