In 2007, a certain pharmaceutical company has some existing semiautomated produc
ID: 2721242 • Letter: I
Question
In 2007, a certain pharmaceutical company has some existing semiautomated production equipment that they are considering replacing. This equipment has a present MV of $60,000 and a BV of $25,000. It has five more years of straight line depreciation available (if kept) of $5,000 per year, at which time its BV would be $0. The estimated MV of the equipment five years from now (in year-zero dollars) is $19,000. The MV rate of increase on this type of equipment has been averaging 3.5% per year. The total operating and maintenance and other related expenses are averaging $27,000 (A$) per year. New automated replacement equipment would be leased. Estimated operating and maintenance and related company expenses for the new equipment are $12,200 per year. The annual leasing cost would be $24,000. The after tax MARR (with an inflation component) is 9% per year (im); t=40%; and the after tax analysis period is five years. Find the incremental IRR of the after tax cash flows (i.e. find delta (defender – challenger) IRR)
a. 3.08%
b. 5.14%
c. 4.36%
d. 3.96%
e. 4.96%
Explanation / Answer
Answer: Option (a): 3.08%
Workings:
Operating Incremental Old machine Leasing Cash flows Initial cost (opportuity cost) 60000 tax @ 40% on gain of 35000 -14000 46000 0 46000 Operating costs: O&M costs 27000 12200 depreciation/lease rent 5000 24000 total operating costs 32000 36200 less: tax shield @ 40% 12800 14480 after tax expenses 19200 21720 less: depreciation 5000 0 after tax annual cash outflows 14200 21720 7520 Terminal value: salvage value 22566 tax on gain (19000*0.4) -9026 Net terminal cash flow 13540 0 13540 For IRR 46000 = 7520*pvifa(r,5) + 13540*pvif(r,5) Using r = 10% 7520*3.7908 + 13540*0.6209 = 28506.82 + 8406.99 = 36913.81 Using r = 5% 7520*4.3295 + 13540*0.7835 = 32557.84 + 10608.59 = 43166.43 Using r = 3% 7520*4.5797 + 13540*0.8626 = 34439.34 + 11679.60 = 46118.94 Exact rate = 3 + 2*(118.94/2952.51) = 3.08%Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.