HOMEWORK

Question 1

The Rustic Welt Company is proposing to replace its old welt-making  machinery with more modern equipment. The new equipment costs $9 million  (the existing equipment has zero salvage value). The attraction of the  new machinery is that it is expected to cut manufacturing costs from  their current level of $8 a welt to $4. However, as the following table  shows, there is some uncertainty both about future sales and about the  performance of the new machinery:

Calculate the annual cost savings of the expected scenario under the  three states of nature. Assume a discount rate of 12%. RW does not pay  taxes.

Question 2

You are the judge in a settlement case. You need to compute the value  of a piece of land in Denver Co. The valuation is subject to the  following conditions

1. The settlement will take place at the end of      2019
2. The current appraised value of the land on 1/1/2018      is $500.000
3. The piece of land has a building on it that is uninhabitable.       It takes one year to bring the building down at a cost of $100,000.  That      money must be paid now.
4. The land can be rented in 2019 at a net proceeds of      40,000
5. While rented the land cost $20,000 in property      taxes
6. Your real estate adviser notes that selling prices of       comparable lands in Denver have declined, in real terms, at an  average      rate of 3% per year over the last 5 years.
7. The cost of capital is 10%
8. The sale of the land at the end of 2019 is subject to      a 10 % commission.

What should someone pay today for this land if given the choice?