Nordique Fab is an Arizona company dedicated to circuit board design and fabrica

Question

Nordique Fab is an Arizona company dedicated to circuit board design and fabrication. It has acquired new stations and software for its three facilities at a cost of $450,000 per site. The estimated MV for each cystm systemg the fourth year is expected to be 5% of the total capital investment, at which time the systems will be sold. The company believes that use of the new systems will enhance their circuit design business resulting in annual income of $1,000,000. annual operating and maintenance costs will be approximately $220,000. The company's marginal effective tax rate is 35% and the MARCS depreciation method (5 year GDS recovery period) will be used. Determine the after tax cash flow for this project. If the after tax MARR is 20% per year, would you recommend this investment?

Explanation / Answer

Since, the systems have been sold in the 4th year, the depreciation, will be calculated upto 4th year.

The after-tax cash flow has been calculated with the use of following table:

_______

Notes:

Loss is the difference between the book value and market value. The book value has been calculated as follows:

Loss on Sale = 1,350,000*5% - (1,350,000 - (270,000 + 432,000 + 259,200 + 155,520)) = $165,780

Loss on Sale will result in tax savings as indicated by a positive cash flow.

_______

To determine whether to invest in the project or not, we need to calculate the NPV with the use of MARR. NPV can be calculated with the use of following formula:

NPV = Cash Flow Year 0 + Cash Flow Year 1/(1+MARR)^1 + Cash Flow Year 2/(1+MARR)^2 + Cash Flow Year 3/(1+MARR)^3 + Cash Flow Year 4/(1+MARR)^4

_______

Using the cash flows calculated above, we get,

NPV = -1,350,000 + 601,500/(1+20%)^1 + 658,200/(1+20%)^2 + 597,720/(1+20%)^3 + 686,955/(1+20%)^4 = $285,522.28

Since, the NPV is positive, the investment should be made.

Year 0 Year 1 Year 2 Year 3 Year 4 Initial Investment (-450,000*3) -1,350,000 Annual Income 0 1,000,000 1,000,000 1,000,000 1,000,000 Less Operating and Maintenance Costs 0 220,000 220,000 220,000 220,000 Depreciation 0 270,000 432,000 259,200 155,520 EBT 0 510,000 348,000 520,800 624,480 Less Taxes 0 178,500 121,800 182,280 218,568 EAT 0 331,500 226,200 338,520 405,912 Add Depreciation 0 270,000 (1,350,000*20%) 432,000 (1,350,000*32%) 259,200 (1,350,000*19.20%) 155,520 (1,350,000*11.52%) Sales Value (1,350,000*5%) 0 0 0 0 67,500 Tax on Loss ((233,280 - 67,500)*35%) 0 0 0 0 58,023 After-Tax Cash Flow -$1,350,000 $601,500 $658,200 $597,720 $686,955

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