1. Siclan Company Problem The Siclan Company is considering opening a new office
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1. Siclan Company Problem The Siclan Company is considering opening a new office. The company owns the building and would sell it for $74,000 after taxes if it does not open the new office. The building has been depreciated down to a zero book value. The equipment that will be used in the building costs $69,000. The equipment that would be used has a 3 year tax life, depreciated straight-line, with 0 scrap value. (If the company tried to sell the equipment at end of year 3, it would receive 0 sales proceeds). (There will be no new revenues after the end of year 3.) No new working capital is required. WACC = 15% Due to opening the office and using the equipment, additional annual Revenues = $100,000 Additional annual Operating cost, excluding depreciation = $20,000 Tax rate = 30% a. What is the required cash outflow associated with the acquisition of a new machine at t = 0? b. What is the project’s NPV? c. Rework the same problem for Siclan company using MACRS depreciation method instead of straight line depreciation. The equipment that would be used has a 3 year tax life, depreciated using MACRS, with a 0 salvage value. No new working capital is required. What is the project NPV? First determine the amount of depreciation each year. Use the depreciation percentages in Table A.1, the Appendix to Chapter 9. For this problem and for the examples that we cover in the asynchronous and synchronous sessions, we will assume that the company puts the equipment into use in year 0 of the project. Remember that Equipment with a 3-year tax life is depreciated over 4 calendar years under MACRS (due to the MACRS ½-year convention). Note: If you scrap the equipment after 3 years, then you would get a tax reduction due to the fact that you had not fully depreciated the machine before you “scrapped” it.
Explanation / Answer
1. Siclan Company Problem
The Siclan Company is considering opening a new office. The company owns the building and would sell it for $74,000 after taxes if it does not open the new office. The building has been depreciated down to a zero book value. The equipment that will be used in the building costs $69,000. The equipment that would be used has a 3 year tax life, depreciated straight-line, with 0 scrap value. (If the company tried to sell the equipment at end of year 3, it would receive 0 sales proceeds). (There will be no new revenues after the end of year 3.) No new working capital is required.
WACC = 15%
Due to opening the office and using the equipment, additional annual Revenues = $100,000
Additional annual Operating cost, excluding depreciation = $20,000
Tax rate = 30%
What is the required cash outflow associated with the acquisition of a new machine at t = 0?
Initial Investment = - Building RelevantCost - Equipment cost
Initial Investment = - 74000 - 69000
Initial Investment = -143000
What is the project’s NPV?
Annual Depreciation = 69000/3 = 23000
Annual Cash Flow = (additional annual Revenues - Additional annual Operating cost, excluding depreciation)*(1-tax rate) + Annual Depreciation*tax rate
Annual Cash Flow = (100000-20000)*(1-30%) + 23000*30%
Annual Cash Flow = 62900
NPV = Initial Investment + PV of annual cash flow
NPV = -143000 + 62900/(1+15%) + 62900/(1+15%)^2+ 62900/(1+15%)^3
NPV =$ 614.86
Rework the same problem for Siclan company using MACRS depreciation method instead of straight line depreciation. The equipment that would be used has a 3 year tax life, depreciated using MACRS, with a 0 salvage value. No new working capital is required. What is the project NPV?
Depreciation in year 1 = 69000*33.33% = 22,997.70
Depreciation in year 2 = 69000*44.45% = 30670.50
Depreciation in year 3 = 69000*14.81% = 10218.90
Cash Flow in year 1 = (additional annual Revenues - Additional annual Operating cost, excluding depreciation)*(1-tax rate) + Annual Depreciation*tax rate
Cash Flow in year 1 = (100000-20000)*(1-30%) + 22997.70*30%
Cash Flow in year 1 = 62899.31
Cash Flow in year 2 = (additional annual Revenues - Additional annual Operating cost, excluding depreciation)*(1-tax rate) + Depreciation*tax rate
Cash Flow in year 2 = (100000-20000)*(1-30%) + 30670.50*30%
Cash Flow in year 2 = 65201.15
Cash Flow in year 2 = (additional annual Revenues - Additional annual Operating cost, excluding depreciation)*(1-tax rate) + Depreciation*tax rate + Tax saving on loss of scrapped
Cash Flow in year 2 = (100000-20000)*(1-30%) + 10218.90*30% + 69000*7.41%*30%
Cash Flow in year 2 = 60599.54
NPV = Initial Investment + PV of annual cash flow
NPV = -143000 + 62899.31/(1+15%) + 65201.15/(1+15%)^2+ 60599.54/(1+15%)^3
NPV =$ 841.67
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