Bizet Electronics has already spent $30,000 to research a project that would req

Question

Bizet Electronics has already spent $30,000 to research a project that would require it to spend $650,000 on new equipment. The equipment is classified as five-year MACRS property. Bizet expects to sell the equipment at the end of five years for $65,000 Five-Year MACRS Depreciation Rates Year -1- 2 3 4 5 6 Rate 20.0032.00 19.20 11.52 11.52 5.76 Pretax annual cost savings from this project are estimated at $300,000, growing at a rate of 3% per year. Working capital equal to $30,000 will be required to support the project at all times up to the project's end (i.e., at times 0 through 5). Only 60% of the working capital will be recovered at the project's end. The equipment would occupy space for which Bizet (the tenant) has no other conceivable use, but is leased under a six-year, noncancelable lease for $45,000 per year. Bizet requires a 15% after-tax rate of return on projects such as this. Bizet is in the marginal 30% income tax bracket with an average income tax rate of 25%. Required: Determine the Net Present Value of this project using the appropriate data above

Explanation / Answer

Year 0 1 2 3 4 5 6 Initial Investment -650000 Increase in Working capital -30000 Research cost - sunk As already incurred 0 Annual Savings (Pre tax) 300000 309000 318270 327818.1 337652.6 347782.2 Less: Tax @ 25% 75000 77250 79567.5 81954.53 84413.16 86945.56 Post tax cost savings 225000 231750 238702.5 245863.6 253239.5 260836.7 Depreciation Factors 0.2 0.32 0.192 0.1152 0.1152 0.0576 Depreciation =(Factor x Cost of equipment) 130000 208000 124800 74880 74880 37440 Depreciation tax savings (Dep x 25%) 32500 52000 31200 18720 18720 9360 Lease rentals are irrelevant as the lease is non cancellable and company has to pay lease whether or not the project is carried out Annual Post tax cost savings 257500 283750 269902.5 264583.6 271959.5 270196.7 Salvage value post tax (65000 x 0.75) 48750 Working capital recovery (60%) 18000 Net cashflows after tax = -680000 257500 283750 269902.5 264583.6 271959.5 336946.7 Present value factors 15% 1 0.869565 0.756144 0.657516 0.571753 0.497177 0.432328 Present value of cash flows -680000 223913 214555.8 177465.3 151276.5 135211.9 145671.3 Net present value = 368093.9 Please provide feedback… Thanks in Advance :-)

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