Hello. I think I am alright with this but have gone wrong in a few places. Pleas
ID: 2328675 • Letter: H
Question
Hello. I think I am alright with this but have gone wrong in a few places. Please provide any workings, explanations and calculations.
George is currently considering the replacement of an old grinder in his workshop. The old grinder was purchased 3 years ago for $40,000. It is being depreciated using the prime (straight line) depreciation method. Its life is 5 years with no salvage value at the end of the 5th year. A trader has offered George $25,000 for the old grinder The new grinder which George would like to purchase costs $70,000. The installation cost is $5,000. This grinder would also be depreciated over 5 years using the prime method. However, at the end of the 5th year, its expected sales value is $5,000. The new grinder requires an increase of $7,550 in net working capital. Tax rate is 30%. Annual revenue and expenses before depreciation, interest and tax are estimated below: PERIOD NEW GRINDER enu Year550,000 Year 2 575,000 Year 3 600,000 Year 4 625,000 Year 5 625,000 490,000 505,000 525,000 545,000 545,000 OLD GRINDER Revenue 500,000 500,000 500,000 500,000 500,000 445,000 445,000 445,000 445,000 445,000Explanation / Answer
7) Initial investment: Installed cost of new Grinder Cost of new Grinder $70,000.00 Add: Installation costs $5,000.00 Total cost of new Grinder $75,000.00 Less: After-tax proceeds from sale of old Grinder Proceeds from sale of old Grinder -$25,000.00 Add : Tax on sale of old Grinder* $2,700.00 Total proceeds from sale of old Grinder -$22,300.00 Change in working capital $7,550.00 Initial investmet $60,250.00 * Proceeds from sale of old Grinder $25,000.00 Less: Book value of old asset = ($40000 - (40000/5) x 3 yrs $16,000.00 Gain on sale of old Grinder $9,000.00 Tax on gain on sale $2,700.00 New Grinder Calculation of Operating Cash Inflows Year Revenue Less: Expenses Profits Before Depreciation and Taxes Depreciation (A) = $75000/5 Net Profits Before Taxes Taxes @ 30% Net Profits After Taxes (B) Operating Cash Inflows A + B 1 $550,000.00 $490,000.00 $60,000.00 $15,000.00 $45,000.00 $13,500.00 $31,500.00 $46,500.00 2 $575,000.00 $505,000.00 $70,000.00 $15,000.00 $55,000.00 $16,500.00 $38,500.00 $53,500.00 3 $600,000.00 $525,000.00 $75,000.00 $15,000.00 $60,000.00 $18,000.00 $42,000.00 $57,000.00 4 $625,000.00 $545,000.00 $80,000.00 $15,000.00 $65,000.00 $19,500.00 $45,500.00 $60,500.00 5 $625,000.00 $545,000.00 $80,000.00 $15,000.00 $65,000.00 $19,500.00 $45,500.00 $60,500.00 Old Grinder Year Revenue Less: Expenses Profits Before Depreciation and Taxes Depreciation (A) = $40000/5 Net Profits Before Taxes Taxes @ 30% Net Profits After Taxes (B) Operating Cash Inflows A + B 1 $500,000.00 $445,000.00 $55,000.00 $8,000.00 $47,000.00 $14,100.00 $32,900.00 $40,900.00 2 $500,000.00 $445,000.00 $55,000.00 $8,000.00 $47,000.00 $14,100.00 $32,900.00 $40,900.00 3 $500,000.00 $445,000.00 $55,000.00 $8,000.00 $47,000.00 $14,100.00 $32,900.00 $40,900.00 4 $500,000.00 $445,000.00 $55,000.00 $0.00 $55,000.00 $16,500.00 $38,500.00 $38,500.00 5 $500,000.00 $445,000.00 $55,000.00 $0.00 $55,000.00 $16,500.00 $38,500.00 $38,500.00 Calculation of Incremental Cash Inflows Year New Grinder Old Grinder Incremental Operating Cash Flow 1 $46,500.00 $40,900.00 $5,600.00 2 $53,500.00 $40,900.00 $12,600.00 3 $57,000.00 $40,900.00 $16,100.00 4 $60,500.00 $38,500.00 $22,000.00 5 $60,500.00 $38,500.00 $22,000.00 Terminal Cash Flow Proceeds from sale of new asset $5,000.00 Tax on sale of new asset -$1,500.00 Total proceeds from sale of new asset $3,500.00 Change in working capital $7,550.00 Terminal cash flow $11,050.00 Net Present Value 8.00% 12.00% 16.00% 20.00% Year Cash Flow PV @8% PV @12% PV @16% PV @20% Present Value Present Value Present Value Present Value 0 -$60,250.00 1 1 1 1 -$60,250.00 -$60,250.00 -$60,250.00 -$60,250.00 1 $5,600.00 0.9259 0.8929 0.8621 0.8333 $5,185.19 $5,000.00 $4,827.59 $4,666.67 2 $12,600.00 0.8573 0.7972 0.7432 0.6944 $10,802.47 $10,044.64 $9,363.85 $8,750.00 3 $16,100.00 0.7938 0.7118 0.6407 0.5787 $12,780.70 $11,459.66 $10,314.59 $9,317.13 4 $22,000.00 0.7350 0.6355 0.5523 0.4823 $16,170.66 $13,981.40 $12,150.40 $10,609.57 5 $33,050.00 0.6806 0.5674 0.4761 0.4019 $22,493.27 $18,753.46 $15,735.54 $13,282.05 $ NPV $7,182.28 -$1,010.84 -$7,858.03 -$13,624.58 6) IRR 11.47% The IRR wouldn't change with change in cost of capital. 7) The project would be accepted when Cost of Capital is 8% because NPV is positive.
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