Problem Company is replacing existing equipment with new equipment which can rep
ID: 2731560 • Letter: P
Question
Problem Company is replacing existing equipment with new equipment which can replicate what the existing machine does and also support a new product line. Old equipment was purchased 3 years ago for 100,000 and was being depreciated using a MACRS 5 year asset class depreciation schedule. It was expected to have a 15,000 salvage value at the end of year 5 when it was planned to be sold. The company is considering replacing it now with a new machine. The old machine can be sold today for 35,000. New machine will cost 180,000 and is expected to have an economic life of 8 years but is expected to use the MACRS 5 year asset class depreciation schedule for tax purposes. It is expected to have a salvage value of 12% of the original equipment costs at the end of 8 years. The remaining operational years beyond the depreciation tax schedule will not have any depreciation expense but will continue to have operational impact. The new machine will require an increase in working capital of 10,000 in the first year of the project and will be fully recovered at the end of the project. The new equipment is expected to increase revenue by 40,000 per year and reduce costs by 5,000 per year before tax impact and consideration of depreciation impact of the new machine. Cost of Capital is 10% and Tax Rate is 40%. A: Base Case scenario - Calculate the project’s NPV - What is your recommendation? B: Alternate Analysis Scenarios - What if revenue impact was only 50% of projections for the first 4 years what would be the impact on NPV? - What if cost reduction assumptions were not realized and no operational costs savings were achieved? What would the impact on NPV be? - What if both alternative scenarios happened concurrently.Explanation / Answer
Answer
Answer (A)
Figures in $
Year
Value of the asset
Depreciation rate
Depreciation
Depreciation tax Benefit
A
B
C
A*B
C*Tax rate
1
1,80,000
20%
36000
14400
2
1,80,000
32%
57600
23040
3
1,80,000
19.20%
34560
13824
4
1,80,000
11.52%
20736
8294.4
5
1,80,000
11.52%
20736
8294.4
6
1,80,000
5.76%
10368
4147.2
Figures in $
Year
Benefit in revenue and costs after tax
Depreciation tax benefit
Purchase of new machine
Selling price of old machine
Working capital
Cashflow
Disc Rate : 10%
Present value
A
B
C
D
E
F
G
(40000+5000)*(1-tax rate)
(as calculated above)
A+B+C+D+E
F*G
0
-1,80,000
35000
-1,45,000
1.00
-145000
1
27000
14400
-10000
31,400
0.91
28545.45
2
27000
23040
50,040
0.83
41355.37
3
27000
13824
40,824
0.75
30671.68
4
27000
8294.4
35,294
0.68
24106.55
5
27000
8294.4
35,294
0.62
21915.05
6
27000
4147.2
31,147
0.56
17581.78
7
27000
27,000
0.51
13855.27
8
27000
21,600
10000
58,600
0.47
27337.33
180000*0.12
Net Present value (NPV)
60368.48
Answer : NPV of the project is $ 60368.48 so company should buy new machine
Figures in $
Year
Value of the asset
Depreciation rate
Depreciation
Depreciation tax Benefit
A
B
C
A*B
C*Tax rate
1
1,80,000
20%
36000
14400
2
1,80,000
32%
57600
23040
3
1,80,000
19.20%
34560
13824
4
1,80,000
11.52%
20736
8294.4
5
1,80,000
11.52%
20736
8294.4
6
1,80,000
5.76%
10368
4147.2
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.