Ford Construction Company is considering the acquisition of a new earthmover. Th

Question

Ford Construction Company is considering the
acquisition of a new earthmover. The mover's
base price is $70.000. and it will cost another
$15,000 to modify it for special use by the com-
pany. This earthmover falls into the MACRS
five-year class. It will be sold after four years
for $30.000. The earthmover purchase will have
no effect on revenues. but it is expected to qave
the firm $32,000 per year in before-tax operat-
ing costs, mainly labor. The firm's marginal tax
rate (federal plus state) is 40%, and its MARR
is 15%.

(a) Is this project acceptable. based on the most
likely estimates given in the problem?

(b) If the firm's MARR is increased to 20%.
what would be the required savings in labor
so that the project remains profitable?

Explanation / Answer

The aftertax savings on operating costs are 32,000 *0.6= 19,200 per year. MACRS depreciation is Year 1 85,000*.20= 17,000. Tax shield is 17,000*.4= 6,800 Year 2 85,000*.32= 27,200 Tax shield is 27,200*.4= 10,880 Year 3 85,000*.1920= 16,320 Tax shield is 16,320 *.4= 6,528 Year 4 85,000* .1152= 9,792 Tax shield is 9,792 *.4= 3,917. Terminal cash flow is sales price of equipment (30,000 less tax due on sale 6,125= 23,875.Tax due on sale is computed by computing cost less accumulated depreciation (14,688), subtracting this from sales price (30,000- 14,688= 15,312) and multiplying this by the tax rate of .4 (15,312*.4= 6,125). So we have cash flows Year 0 (85,000) Present value factor 1.0 Year 1 26,000 Present value factor 0.8696 Year 2 30,080 Present value factor 0.7561 Year 3 25,278 Present value factor 0.6575 Year 4 23,117 Present value factor 0.5717 Terminal (Year 4) 23,875 Present value factor 0.5717 If we discount these by the present value factors and add we get a positive net present value of 4,139 so the project should be undertaken. I'll answer the second question on another post. Year 3

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