33. Cranberry Manufacturing Company is considering an asset replacement project
ID: 2654857 • Letter: 3
Question
33. Cranberry Manufacturing Company is considering an asset replacement project of replacing a control device. This old control device has been fully depreciated but can be sold for $4,000. The new control device, which is more automated, will cost $22,000. The new device’s installation and shipping costs will total $10,000. The new device will be depreciated on a straight-line basis over its 2-year economic life to an estimated salvage value of $0. The actual salvage value of this device at the end of 2-year period (That is, the market value of the device at the end of 2-year period) is estimated to be $3,000. If the replacement project is accepted, Cranberry will require an initial working capital investment of $3,000 (that is, adding $3,000 initially to its net working capital).
During the 1st year of operations, Cranberry expects its annual revenue to increase from $65,500 to $85,000. After the 1st year, revenues from the replacement are expected to increase at a rate of $2,200 a year for the remainder of the project life.
Cranberry's incremental operating costs associated with the replacement project are expected to decrease from $20,000 to $12,000 during the 1st year and increase at a rate of $2500 for the remainder of the project life.
Cranberry expects that it will have to add about $2,000 to its net working capital in year 1, and nothing in year 2. At the end of the project, the total accumulated net working capital required by the project will be recovered.
Cranberry has a marginal tax rate of 35%.
A. $31,785
B. $30,905
C. $30,230
D. $35,210
FYI: **Calculated from a previous question: Initial Net Income = $32,400**
What is the net operating cash flow at the end of year 2?Explanation / Answer
Option B
Revenue in year 2 would be 85000 + 2200 = 87200
Cost would be 16000 + 20000 + 12000 = 48000
Depreciation would be 16000
So EBIT would be 23200
And tax at 35% would be 8120
Therefore, OCF = EBIT + Depreciation – Tax
= 23200 + 16000 – 8120 = 31080
Closest answer is 30905 which is option B
Note: Cost in year 0 was calculated using Net Income from year 0, which was 32400.
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