Harriman Manufacturing Co. is evaluating the purchase of a new forklift. The quo

Question

Harriman Manufacturing Co. is evaluating the purchase of a new forklift. The quoted price is $50,000, and it would cost Harriman another $10,000 for related capital costs such as transportation and equipment modification for special use. The total investment would fall into MACRS three year class with depreciation rates being applied to the full capitalized costs, not deducting salvage, at 33%, 45%, 15% and 7% in years 1-4, respectively. Harriman expects that the equipment would be sold in the fourth year, after three years of use, for a price of $25,000. During the three year operating period spare parts inventory would increase by $3,000 to maintain the equipment, but non-interest bearing accounts payable would increase by $1,000. Although the equipment is not expected to increase the firm's revenue, it is expected to save it $20,000 in before tax labor operating costs annually. (Problem setup is important.) (Clue: When do you need spare parts?)

a. Calculate the expected net cash outlay at the beginning of the first year.

b. Estimate the net operating cash flows in years 1, 2 and 3, and assume they occur at the end of each year.

c. What is the dollar value of the net cash terminal value in the fourth year?

d. If Harriman's weighted average cost of capital is 10%, what are the investment's

i. Net Present Value?

ii. Internal Rate of Return?

iii. Simple Payback Period?

iv. Should the investment be made? Why or why not?

Explanation / Answer

(a) Calculation of cash flow at the beginning of the year -

Note - Net Working capital sparte part needed less accounts payable

= 3000 - 1000 = 2000

(b) Calculation of Net operating cash flow in year 1,2 & 3 -

Following shows the calculation -

(c) Calculation of terminal value in the fourth year -

Terminal value in the fourth year would be = 20800

Calculation part has been shown in above(2) part.

(d) Calculation of NPV -

(ii) Calculation of IRR -

(iii) Calculation of Simple payback period -

payback period = 3years + 2000/25000*12

= 3 years and 1 month.

(iv) Yes as per NPV the investment would be made but as per payback should not because the payback is higher than the project finished year.

In case of further clarification required please comment.

Year 0 Initial Investment -60000 Saving in cost less Depriciation Spare part needed /working capital -2000 EBIT add Salvage value Taxable income less Tax - Not given EAT add Depriciation Cash flow after tax -62000 Discounting @ 10% 1 -62000

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