Kirksville Company is considering a new assembly line to replace the existing as
ID: 2653137 • Letter: K
Question
Kirksville Company is considering a new assembly line to replace the existing assembly line. The assembly line would require to use a parcel of land that cost $800,000 three years ago. But the land can be sold for $1,000,000 today and is expected to be sold for $1,200,000 five years from now. The company conducted a marketing survey for the feasible impact of the new assembly line, if replaced, on the company’s cash flow six months ago, costing $25,000.
The existing assembly line was installed 3 years ago at a cost of $80,000; it was being depreciated under the straight-line method. The existing assembly line is expected to have a usable life of 5 more years. The new assembly line costs $120,000; requires $5,000 in installation costs and $3,000 in training fees; it has a 5-year usable life and would be depreciated under the straight-line method.
The new assembly line will increase output and thereby raises sales by $15,000 per year and will reduce production expenses by $5,000 per year. The existing assembly line can currently be sold for $10,000. To support the increased business resulting from installation of the new assembly line, the firm will also need to increase account payables by $2,500 and decrease inventory by $1,500 for the project.
At the end of 5 years, the existing assembly line is expected to have a market value of $1,000; the new assembly line would be sold to net $20,000 before taxes. Finally, to install the new assembly line, the firm would have to borrow $80,000 at 10% interest from its local bank, resulting in additional interest payments of $8,000 per year. The firm pays 34% taxes and its shareholders require 10% return.
(a) (6 points) What is the initial outlay associated with this project?
(b) (3 points) What is the operating cash flow per year?
(c) (4 points) What is the terminal cash flow?
(d)(2 points) Find NPV for this project. Should this machine be replaced? Explain why.
Explanation / Answer
a. Initial Outlay = Cost of Land today + Cost of Replacement + New Assembly Line Cost + Installation Cost +
Training Fees - Salvage of existing assembly line + Working Capital
= 1000000 + 25000 + 120000 + 5000 + 3000 - 10000 + 2500 + 1500= $1147000
b. Operating Cash Flows per year = Increase in Sales + Decrease in prod. expenses - Interest on Loan - Tax
= 15000 + 5000 - 8000 - (20000 - 8000 - Increase in depreciation)*0.34
= 12000 - (12000- (21600-9875))*0.34
= 12000 - 94 = $11906
c. Terminal Cash Flows = Sale of Land - Tax on Sale of Land + Working Capital Reversal + Increase
in Salvage Value - Tax on Increase
= 1200000 - (200000*0.34) + 4000 + (20000-1000) - (19000*0.34)
= $1148540
d. NPV of the project:
The machine should not be repalced as the NPV is negative.
Year Particulars Cash Flows PVF@10% Amount 0 Initial Investment -1147000 1 -1147000 1-5 Operating Cash Flows 11906 3.791 45136 5 Terminal Cash Flows 1148540 0.621 713243 NPV -388621Related Questions
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