4. (10 pts) IQ Electronics, which assembles printed circuit boards, is consideri
ID: 2524423 • Letter: 4
Question
4. (10 pts) IQ Electronics, which assembles printed circuit boards, is considering the purchase of a new IC chip placement machine. It has a first cost of $300,000 and is expected to save them $125,000 per year in labour and operating costs compared with the system they have now. The life of the system is expected to be four years. The salvage value of the machine is expected to be $100,000. IQ's nominal tax rate is 40%, and the equipment CCA rate is Class 8 declining balance with only half of the CCA eligible in year 1. What is the net present worth, given an MARR of 15%? Should IQ proceed with this purchase? 5. (10 pts) Referring to question 4 above, if the initial investment of $300,000 must be financed by a bank, at an effective annual interest rate of 12%/year over 4 years, is the project still worth pursuing? Compare your answer with Question 4, explain in one sentence what has happened.Explanation / Answer
4) In order to determine acceptance of the purchase, we need to determine NPV of buying the machine.
NPV = Present Value of all cash-inflows – Initial investment
Initial investment = $300,000
Year
0
1
2
3
4
Initial Cash Outlay
-300,000
Annual Saving
125,000
125,000
125,000
125,000
Less: Depreciation
60,000
96,000
57,600
34,560
Profit before tax
65,000
29,000
67,400
90,440
Tax at 40%
26,000
11,600
26,960
36,176
Net Income
39,000
17,400
40,440
54,264
Add: Depreciation
60,000
96,000
57,600
34,560
Add: After-tax Salvage Value
-
-
-
80,736
Operating cash Flow
99,000
113,400
98,040
88,824
Free Cash Flow
-300,000
99,000
113,400
98,040
169,560
Disc factor = 1/(1+15%)^n
1.00000
0.86957
0.75614
0.65752
0.57175
Disc. Cash Flow
-300,000
86,087
85,747
64,463
96,946
NPV = ($86,087 + $85,747 + $64,463 + $96,946) - $300,000 = $33,243
Since the NPV is positive, the machine should be purchased.
Working of Depreciation and After-tax Salvage Value:
Depreciation Table
Year
1
2
3
4
Rate of Depreciation
20%
40%
40%
40%
Beg. Balance
300,000
240,000
144,000
86,400
Depreciation
60,000
96,000
57,600
34,560
Ending Balance
240,000
144,000
86,400
51,840
After-tax Salvage Value = $100,000 – [($100,000 - $51,840)*40%] = $80,736
5) In this case, the required rate of return has decreased to 12% from 15% in Question 4. A decreased required rate of return would result in higher NPV and hence, the final decision would not change.
Year
0
1
2
3
4
Initial Cash Outlay
-300,000
Annual Saving
125,000
125,000
125,000
125,000
Less: Depreciation
60,000
96,000
57,600
34,560
Profit before tax
65,000
29,000
67,400
90,440
Tax at 40%
26,000
11,600
26,960
36,176
Net Income
39,000
17,400
40,440
54,264
Add: Depreciation
60,000
96,000
57,600
34,560
Add: After-tax Salvage Value
-
-
-
80,736
Operating cash Flow
99,000
113,400
98,040
88,824
Free Cash Flow
-300,000
99,000
113,400
98,040
169,560
Disc factor = 1/(1+15%)^n
1.00000
0.86957
0.75614
0.65752
0.57175
Disc. Cash Flow
-300,000
86,087
85,747
64,463
96,946
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