Your company, Dawgs “R” Us, is evaluating a new project involving the purchase o

Question

Your company, Dawgs “R” Us, is evaluating a new project involving the purchase of a new oven to bake your hotdog buns. If purchased, the new oven will replace your existing oven, which was purchased seven years ago for a total installed price of $1 million.

You have been depreciating the old oven on a straight-line basis over its expected life of 15 years to an ending book value of $250,000, even though you expect it to be worthless at the end of that 15-year period. The new oven will cost $2 million and will fall into the MACRS 5-year depreciation class life. If you purchase the new oven, you expect it to last for eight years. At the end of those eight years, you expect to be able to sell it for $100,000. (Note that both of the ovens, old and new, therefore have an effective remaining life of eight years at the time of your analysis.) If you do purchase the new oven, you estimate that you can sell the old one for its current book value at the same time.

The advantages of the new oven are twofold: Not only do you expect it to reduce the before-tax costs on your current baking operations by $75,000 per year, but you will also be able to produce new types of buns. The sales of the new buns are expected to bring your company $200,000 per year throughout the eight-year life of the new oven, while associated costs of the new buns are only expected to be $80,000 per year.

Since the new oven will allow you to sell these new products, you anticipate that NWC will have to increase immediately by $20,000 upon purchase of the new oven. It will then remain at that increased level throughout the life of the new oven to sustain the new, higher level of operations.

Your company uses a required rate of return of 12 percent for such projects, and your incremental tax rate is 34 percent. What will be the total cash flows for this project?

Please show work in excel. -Thank you

Explanation / Answer

Cash Flows of the project

Year Particulars Amount PVF Present Value 0 Purchase of New Oven -2000000 1 -2000000 0 Selling Price of Old Oven 250000 1 250000 0 Increase in NWC -20000 1 -20000 1 Tax Saving on Depreciation 2000000*1/8*200%*0.34 170000 0.893 151810 2 Tax Saving on Depreciation 1500000*1/7*200%*0.34 145714 0.797 116134 3 Tax Saving on Depreciation 1071429*1/6*200%*0.34 121429 0.712 86457 4 Tax Saving on Depreciation 714286*1/5*200%*0.34 97143 0.636 61783 5 Tax Saving on Depreciation 428572*1/4*200%*0.34 72857 0.567 41310 6 Tax Saving on Depreciation 214286*1/3*200%*0.34 48572 0.507 24626 7 Tax Saving on Depreciation 71429*1/2*200%*0.34 24286 0.452 10977 8 Tax Saving on Depreciation 0 0 0.404 0 1 to 8 Savings per year after tax (75000+200000-80000)*0.66 128700 per year 4.968 639382 8 Release of NWC 20000 0.404 8080

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