Your hired an accounting firm WAAC to evaluate your compan\'s production line. A

Question

Your hired an accounting firm WAAC to evaluate your compan's production line. After careful research, WAAC recommended you to upgrade your production line by purchasing the latest Super Machine and selling the old machine which has already fully depreciated. WAAC summary report: Super machine cost $5 million, it has a life of 5 years with 0 salvage value. At the end of year 2 when the project ends, you may sell it back to the original manufacture for 3.5 million. The Super Machine produces higher quality products so it increases each years sales revenue by $1 million. At the same time, it also decreases the cost by $100,000 every year. Due to the machine efficency, the inventory level of each year is reduced by $0.5 million. The market value for the old machine is $1 million at this time. Assume 35% corporate tax rate, 15% capital gain tax, and a 10% discount rate. Assume straight line depreciation.

Explanation / Answer

Solution -

0 1 2 Total Initial Cash Inflow / Investment -5000000 Increased sales 1000000 1000000 Saving on reduced Cost 100000 100000 Annual operating costs Depreciation @ % of depreciation given -1000000 -1000000 Net Profit 100000 100000 Taxes at 35% of Net Profit 35000 35000 Profit after Tax 65000 65000 Net Cash Flow ( add back Depreciation) 1065000 1065000 Change in Inventory 500000 -500000 Salvage Value 3425000 Sale of old machine 850000 Final /Total Net Cash Flow -3650000 1065000 3990000 Present Value factor @ 10% 1 0.9091 0.8264 Net Present Value -3650000 968181.818 3297520.66 615702.479

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