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 21% 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.

Answer 1

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)