Edward Laren, an accountant with Tenergy Industries, prepared the following anal

ID: 2381091 • Letter: E

Question

Edward Laren, an accountant with Tenergy Industries, prepared the following analysis of an investment in manufacturing equipment:

Cost savings: Labor savings $535,000 Reduction in rework materials 125,800 Other 63,200 Total 724,000 Additional taxes related to cost savings (253,400) Tax savings related to depreciation of new equipment 161,210 Annual cash flow $631,810 Present value at 10 percent for five years $2,395,065 Cost of equipment (2,303,000) Net present value $92,065
Edward Edward Laren, an accountant with Tenergy Industries, prepared the following analysis of an investment in manufacturing equipment:

Cost savings: Labor savings $535,000 Reduction in rework materials 125,800 Other 63,200 Total 724,000 Additional taxes related to cost savings (253,400) Tax savings related to depreciation of new equipment 161,210 Annual cash flow $631,810 Present value at 10 percent for five years $2,395,065 Cost of equipment (2,303,000) Net present value $92,065
Edward Problem 9-14 Edward Laren, an accountant with Tenergy Industries, prepared the following analysis of an investment in manufacturing equipment: Edward's boss, Megan Mangione, reviewed the calculation and made the following observation: " Ed, you've assumed that there won't be inflation, but inflation is built into our 10 percent cost of capital. I think it's reasonable to assume that labor and costs other than depreciation will increase by 5 percent per year. Why don't you redo the analysis with that assumption?" Redo Edward Laren's analysis assuming an inflation rate of 5 percent. Should the company make the investment in the equipment? (Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).)

Explanation / Answer

Nominal discount rate = [(1.1/1.05)-1] = 4.76%

Cost savings:

Labor savings

$535,000

Reduction in rework materials

125,800

Other

63,200

Total

724,000

Additional taxes related to cost savings

(253,400)

Annual cash flow excluding depreciation

$470600

Present value of the above at 10% for five years

[470600*3.7908]

$1783950

Tax savings related to depreciation of new equipment

$161,210

Present value of the above at 4.76% for 5 years

[161210*4.3584]

$702618

Total present value [2051063+611115]

$2486568

Cost of equipment

(2,303,000)

Net present value

183568

Note:-Tax savings related to depreciation of new equipment is discounted at

Nominal rate {discount rate not having the effect of inflation} as it does

Includes inflation.

The discount rate of 10% given in the question includes the effect of inflation

The company must accept the project