Fiber Glasses must choose one of two facilities. Facility I costs $5.0 million a
ID: 2711281 • Letter: F
Question
Fiber Glasses must choose one of two facilities. Facility I costs $5.0 million and its economic and depreciation life is 4 years. The maintenance costs for facility I are $80,000 per year (for 4 years).
Facility II costs $7 million, has an economic life of 7 years and a depreciation life of 4 years. The annual maintenance costs for facility II are $100,000 per year (for 7 years).
Both facilities should be fully depreciated using the straight line method. The facilities have no value after their economic lives. The corporate tax rate is 34 percent. Revenues from the facilities are the same. The company is assumed to generate sufficient revenues to generate tax shields from depreciation. If the appropriate discount rate is 12 percent, which facility should Fiber Glasses choose? Why?
Explanation / Answer
Facility 1 should be choosen by Fiber Glasses because its NPV of Faclilty is Profitable than the Facility 2( loss)
Notes: Facility 1
present value of maintenance cost = $80000 * PVAF(12% , 4)
= $80000 * 3.037
= $242960
tax saving from depreciation = depreciation per year * tax rate / (1+ 0.12)4
= (5000000 / 4) * 0.34 / (1.12)4
= 425000 / 1.57
$ 270701
Less :present value of cash flow = (242960)
NPV $ 27741
Facility 2
present value of maintenance cost = $100000 * PVAF(12% , 7)
=$100000 * 4.564
= $ 456400
tax saving from depreciation = depreciation per year * tax rate / (1+ 0.12)7
= (7000000 / 4) * 0.34 / (1.12)7
= 595000 / 2.21
$ 269231
Less: present value of cash flow = ($456400)
NPV = ($ 187169)
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