A senior design project has a total capital investment of S15:500:000: of which
ID: 2772747 • Letter: A
Question
A senior design project has a total capital investment of S15:500:000: of which 10% is working capital. Their net annual profits are S3:500:000 in the first ten years of their plant's life, and S3:100:000 afterword. Their plant has a total lifetime of 25 years, and their company expects 15% return on all investments. What is the net present worth of this project? The initial installed cost for a new piece of equipment is S10:000. After the equipment has been in use for 4 years, it is sold for S7:000. The company that originally owned the equipment employs a straight-line method for determining depreciation costs. If the company had used the MACRS 5-year method for determining depreciation costs, the asset or book value for the piece of equipment at the end of 4 years would have been SI 728. The total income tax rate for the company is 35% of all gross earnings. Capital gains taxes amount to 20% of the gain. How much net savings would the company have achieved by using the MACRS method instead of straight-Une depreciation method?Explanation / Answer
1) Capital Investment in Plant = 15500000 * (1-10%) = $ 13,950,000
Capital Investment in Working Capital = 15500000 * 10% = $ 1,550,000
Annual Depreciation Straight Line Depreciation = 13950000/25 = 558000
Annual Cash Flow in 1st 10 Year = Net Annual Profit + Annual Depreciation
Annual Cash Flow in 1st 10 Year = 3500000+558000
Annual Cash Flow in 1st 10 Year = 4058000
Annual Cash Flow in remaining 15 Year = Net Annual Profit + Annual Depreciation
Annual Cash Flow in remaining 15 Year = 3100000+558000
Annual Cash Flow in remaining 15 Year = 3658000
Working capital realised at the end = 1,550,000
Present worth of this project = -Total Capital Investment + Pv of Annual Cash Flow in 1st 10 Year + PV of Annual Cash Flow in remaining 15 Year + PV of Working capital realised at the end
Present worth of this project = -15500000 + 4058000*(1-(1+15%)^-10)/15% + (3658000*(1-(1+15%)^-15)/15%)/1.15^10 + 1550000/1.15^25
Present worth of this project = $ 10,200,450.14
Note : Assuming Annual depreciation is being deducted in annual net profit using Straight line method
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