Macon Company is considering a new assembly line to replace the existing assembl

Question

Macon Company is considering a new assembly line to replace the existing assembly line. The existing assembly line was installed 2 years ago at a cost of $90,000; it was being depreciated under the straight-line method. The existing assembly line is expected to have a usable life of 4 more years. The new assembly line costs $120,000; requires $8,000 in installation costs and $5,000 in training fees; it has a 4-year usable life and would be depreciated under the straight-line method. The new assembly line will increase output and thereby raises sales by $10,000 per year and will reduce production expenses by $5,000 per year. The existing assembly line can currently be sold for $15,000. To support the increased business resulting from installation of the new assembly line, accounts payable would increase by $5,000 and accounts receivable by $12,000. At the end of 4 years, the existing assembly line is expected to have a market value of $4,000; the new assembly line would be sold to net $15,000 before taxes. Finally, to install the new assembly line, the firm would have to borrow $80,000 at 10% interest from its local bank, resulting in additional interest payments of $8,000 per year. The firm pays 34% taxes and its shareholders require 10% return.

A. What is the initial cash outlay for this replacement project?

B. What is the operating cash flow of the project?

C. What is the terminal cash flow of the project?

D. Should you replace the existing assembly line? Provide all the details.

Please write out all equations and steps to get the solution!! Thank you!

Explanation / Answer

Answer

Answer (A) (B) (C) & (D)

Year

Depreciation on new assembly line

Depreciation on existing assembly line

Incremental Depreciation

Incremental Depreciation Tax Benefit

A

B

C

A-B

C*Tax rate

(120000+8000+5000)/4

(90000/6)

1

33250

15000

18250

6205

2

33250

15000

18250

6205

3

33250

15000

18250

6205

4

33250

15000

18250

6205

Figures in $

Year

Rise in Sales and reduction in production expenses

Interest on loan

Incremental Depreciation Tax Benefit

Loan

Incremental Cost of New assembly over sale price of old assembly

Working Capital

Incremental Salvage value after taxes

Cash flow

Disc Rate : 10%

Present value

A

B

C

D

E

F

G

H

I

A+B+C+D+E+F+G

H*I

10000+5000

8000*(1-tax rate)

As per above table

(120000+8000+5000)-15000

5000-12000

(15000-4000)*(1-tax rate)

0

80000

-118000

-7000

-45000

1

-45000.00

1

15000

-5280

6205

15925

0.909091

14477.27

2

15000

-5280

6205

15925

0.826446

13161.16

3

15000

-5280

6205

15925

0.751315

11964.69

4

15000

-5280

6205

-80000

7000

7260

-49815

0.683013

-34024.32

Net Present value

-39421.20

Answer : You should not replace the existing assembly line as net Present value is negative (-39421.20)

Year

Depreciation on new assembly line

Depreciation on existing assembly line

Incremental Depreciation

Incremental Depreciation Tax Benefit

A

B

C

A-B

C*Tax rate

(120000+8000+5000)/4

(90000/6)

1

33250

15000

18250

6205

2

33250

15000

18250

6205

3

33250

15000

18250

6205

4

33250

15000

18250

6205

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