Degnan Dance Company, Inc., a manufacturer of dance and exercise apparel, is con
ID: 2708253 • 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.
Existing Machine
Cost = $100,000
Purchased 2 years ago
Depreciation using MACRS over 5-year recovery schedule
Current market value = $105,000
Five year usable life remaining
Proposed Machine
Cost = $150,000
Installaion = $20,000
Depreciation - the MACRS a 5-year recovery schedule will be used
Five year usable life expected
Earnings before Depreciation and Taxes
Existing Machine
Year
1 $160,000
2 $150,000
3 $140,000
4 $140,000
5 $140,000
Proposed Machine
1 $170,000
2 $170,000
3 $170,000
4 $170,000
5 $170,000
The firm pays 40% taxes on ordinary income and capital gains
CALCULATE THE NET PRESENT VALUE
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Explanation / Answer
The required rate of return is 10%
Incremental cash flows:
Proposed machine:
Initial cash flows: Purchase price + installation = $170,000
Operating cash flows:
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
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