Degnan Dance Company, Inc., a manufacturer of dance and exercise apparel, is con
ID: 2679071 • Letter: D
Question
Degnan Dance Company, Inc., a manufacturer of dance and exercise apparel, is considering replacing an existing piece of equipment with a more sophisticated machine. The following information is given.Exsting machine/ proposed machine
$100,000/ $150,000
Purchased 2 years ago/ Installation $20,000
Depreciation using MACRS over a 5-year recover schedule/ Depreciation - the MACRS
Current market value = $105,000/ 5 year recvery schedule will be used
Five year usable life remaining/ five year usable life expected
Earnings before depreciation and taxes:
Year/ Existing machine/ proposed machine
1/ $160,000/ $170,000
2/$150,000/ $170,000
3/$140,000/$170,000
4/$140,000/$170,000
5$140,000/$170,000
The firm pays 40 percent taxes on ordinary income and capital gains. Degnan
Explanation / Answer
Using a 5-yr MACRS schedule, depreciation for the proposed machine for 5 years is:
Yr. 1: 170000 * 0.2 = 34000
2: 170000 * 0.32 = 54400
3: 32640
4: 19580
5: 19580
OCFs: Yr 1 2 3 4 5
EBDepr 170000 170000 170000 170000 170000
- Depr 34000 54400 32640 19580 19580
EBIT 136000 115600 137360 150420 150420
-taxes 54400 46240 54948 60168 60168
+Depr 34000 54400 32640 19580 19580
OCF 115600 123760 115052 109832 109832
Terminal cash flow:
Sale of proposed machine (at book value):
Book value = 170000 – 34000 – 54400 – 32640 – 19580 – 19580 = 9800
Existing machine:
Sale of existing machine (included in initial cash flows):
Book value = 100000 – (100000 * 0.2) – (100000 * 0.32) = 48000
Cash flow from sale: 105000 – (105000 – 48000) * 0.4 = 82200
Operating cash flows lost:
The existing machine is to be used for 5 more years:
Depreciation:
Yr. 1: 100000 * 0.192 = 19200
2: 100000 * 0.1152 = 11520
3: 100000 * 0.1152 = 11520
4: 100000 * 0.0576 = 5760
5: 0
OCFs: Yr 1 2 3 4 5
EBDepr 160000 150000 140000 140000 140000
- Depr 19200 11520 11520 5760 0
EBIT 140800 138480 128480 134240 140000
-taxes 56320 55392 51392 53696 56000
+Depr 19200 11520 11520 5760 0
OCF 103680 94608 88608 86304 84000
NPV:
(-170000 + 82200) + (115600 – 103680)/1.1
+ (123760 – 94608)/1.1^2 + (115052 – 88608) / 1.1^3 + (109832 – 86304)/1.1^4
+ (109832 + 9800 – 84000) / 1.1^5 = 5191
ACCEPT
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