Heaps Company produces jewelry that requires electroplating with gold, silver, a
ID: 2500212 • Letter: H
Question
Heaps Company produces jewelry that requires electroplating with gold, silver, and other valuable metals. Electroplating uses large amounts of water and chemicals, producing wastewater with a number of toxic residuals. Currently, Heaps uses settlement tanks to remove waste; unfortunately, the approach is inefficient, and much of the toxic residue is left in the water that is discharged into a local river. The amount of toxic discharge exceeds the legal, allowable amounts, and the company is faced with substantial, ongoing environmental fines. The environmental violations are also drawing unfavorable public reaction, and sales are being affected. A lawsuit is also impending, which could prove to be quite costly.
Management is now considering the installation of a zero-discharge, closed-loop system to treat the wastewater. The proposed closed-loop system would not only purify the wastewater, but also produce cleaner water than that currently being used, increasing plating quality. The closed-loop system would produce only four pounds of sludge, and the sludge would be virtually pure metal, with significant market value. The system requires an investment of $620,200 and will cost $45,150 in increased annual operation plus an annual purchase of $7,760 of filtration medium. However, management projects the following savings:
The equipment qualifies as a seven-year MACRS asset. Management has decided to use straight-line depreciation for tax purposes, using the required half-year convention. The tax rate is 40 percent. The projected life of the system is 10 years. The hurdle rate is 16 percent for all capital budgeting projects, although the company’s cost of capital is 12 percent. Present value tables must be used.
1. Based on the financial data provided, prepare a schedule of expected cash flows. Enter cash outflows as negative amounts and cash inflows as positive amounts.
Year 0: ?
Year 1:
Operating Costs: ?
Savings: ?
Depreciation Shield: ?
Total: ?
Year 2-7:
Operating Costs: ?
Savings: ?
Depreciation Shield: ?
Total: ?
Year 8:
Operating Costs: ?
Savings: ?
Depreciation Shield: ?
Total: ?
Year 9-10:
Operating Costs: ?
Savings: ?
Total: ?
2. What is the payback period in years?
3. Calculate NPV of the closed-loop system. Round intermediate calculations and final answer to the nearest dollar
4. The calculation in Requirement 3 ignored several factors that could affect the project’s viability: savings from avoiding the annual fines, positive effect on sales due to favorable environmental publicity, increased plating quality from the new system, and the avoidance of the lawsuit. Can these factors be quantified?
5. Suppose, for example, that the annual fines being incurred are $75,390, the sales effect is $60,020 per year, the quality effect is not estimable, and cancellation of the lawsuit because of the new system would avoid an expected settlement at the end of Year 3 (including legal fees) of $308,300. Assuming these are all after-tax amounts, what effect would their inclusion have on the payback period? On the NPV? Round payback to two decimal places and round NPV calculation and final answer to the nearest dollar.
Water usage $ 67,760 Chemical usage 42,370 Sludge disposal 89,710 Recovered metal sales 44,970 Sampling of discharge 120,560 Total $ 365,370Explanation / Answer
1)
Year 0: -620200
Year 1:
Operating Costs = (-45150-7760)*(1-40%) = - $ 31,746
Savings = 365370*(1-40%) = $ 219,222
Depreciation Shield = 44300*40% = $ 17,720
Total = $ 205,196
Year 2-7:
Operating Costs = (-45150-7760)*(1-40%) = - $ 31,746
Savings = 365370*(1-40%) = $ 219,222
Depreciation Shield = 88600*40% = $ 35,440
Total = $ 222,916
Year 8:
Operating Costs = (-45150-7760)*(1-40%) = - $ 31,746
Savings = 365370*(1-40%) = $ 219,222
Depreciation Shield = 44300*40% = $ 17,720
Total = $ 205,196
Year 9-10:
Operating Costs = (-45150-7760)*(1-40%) = - $ 31,746
Savings = 365370*(1-40%) = $ 219,222
Total = $ 187476
2. What is the payback period in years?
Payback period in years = Year 1 + (Initial Investment - Year 1 cash inflow)/Annual cash flow from year 2-7
Payback period in years = 1 + (620200-205196)/222916
Payback period in years = 2.86 years
3. Calculate NPV of the closed-loop system. Round intermediate calculations and final answer to the nearest dollar
NPV = Year 0 Cash Flow + Year 1 Cash Flow*PVIF(16%,1) + Annual Cash Flow Year 2-7*PVIFA(16%,6)*PVIF(16%,1) +Year 8 Cash Flow*PVIF(16%,8) + Year 9 Cash Flow*PVIF(16%,9) + Year 10 Cash Flow*PVIF(16%,10)
NPV = - 620200 + 205196*0.86207 + 222916*3.68474 *0.86207 + 205196*0.30503 + 187476*0.26295 + 187476*0.22668
NPV = $ 419,171.65
4. The calculation in Requirement 3 ignored several factors that could affect the project’s viability: savings from avoiding the annual fines, positive effect on sales due to favorable environmental publicity, increased plating quality from the new system, and the avoidance of the lawsuit. Can these factors be quantified?
Yes these factor should be quantified
5)
Year 1 Cash Flow = 205196 + 75390+60020 = $ 340606
Year 2 Cash Flow = 222916 + 75390+60020 = $ 358,326
Payback period in years = 1 + (620200-340606)/358326
Payback period in years = 1.78 years
Annual Cash flow from annual fines saved & sales effect = 75390+60020 = 135410
Year 3 saving on cancellation of the lawsuit = $ 308300
NPV would increase by = Annual Cash flow from annual fines saved & sales effect*PVIFA(16%,10) + Year 3 saving on cancellation of the lawsuit*PVIF(16%,3)
NPV would increase by = 135410*4.83323 + 308300*0.64066
NPV would increase by = $ 851,983.15
New NPV = 419171.65+ 851,983.15
New NPV = $ 1,271,154.80
Working
Annual Depreciation as per straight line method = (620200)/7
Annual Depreciation as per straight line method = 88600
Depreciation for year 1 & Year 8 = Annual Depreciation as per straight line method *1/2
Depreciation for year 1 & Year 8 = 88600*1/2
Depreciation for year 1 & Year 8 = 44300
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