Question
In: Accounting
You are considering the following capital investment. You can buy a shoelace manufacturing machine for 7...
You are considering the following capital investment. You can buy a shoelace manufacturing machine for 7 million dollars. The machine would be depreciated using straight-line depreciation over 7 years. Assume first that the revenue from shoelace sales would be 3.2 million dollars per year, and variable costs would be 2 million per year. Assuming your firm has a beta of 1.2 and is all equity financed, and that the expected return on the market is 8% that the risk-free rate is 1%, and your firm has a marginal tax rate of 21%, is this a good investment?
1.b) How much is the option to sell the machine after 5 years for 3 million dollars (and exit the business) worth to you
1,c) If you can sell shoelaces at $2 and have variable costs of $0.50, how many shoelaces do you need to sell to have an accounting breakeven?
1.d) How many do you need to sell to have positive EVA/NPV?
Solutions
Expert Solution
| 1) | ($ millions) | ||||||||
| Year | Cash inflow | Cash outflow | Net Cashflow | Depreciation | Net profit | Tax @21% | Cashflow after tax | PVF @ 9.40 % | Discounted Value |
| (a) | (b) | (c ) | (d=b-c) | (e ) | (f=d-e) | (g=f x 21%) | (h=d-g) | (i) | (J=h x i) |
| - | - | 7.00 | -7.00 | - | -7.00 | - | -7.00 | 1.00 | -7.00 |
| 1 | 1.20 | - | 1.20 | 1.00 | 0.20 | 0.04 | 1.16 | 0.91 | 1.06 |
| 2 | 1.20 | - | 1.20 | 1.00 | 0.20 | 0.04 | 1.16 | 0.84 | 0.97 |
| 3 | 1.20 | - | 1.20 | 1.00 | 0.20 | 0.04 | 1.16 | 0.76 | 0.88 |
| 4 | 1.20 | - | 1.20 | 1.00 | 0.20 | 0.04 | 1.16 | 0.70 | 0.81 |
| 5 | 1.20 | - | 1.20 | 1.00 | 0.20 | 0.04 | 1.16 | 0.64 | 0.74 |
| 6 | 1.20 | - | 1.20 | 1.00 | 0.20 | 0.04 | 1.16 | 0.58 | 0.68 |
| 7 | 1.20 | - | 1.20 | 1.00 | 0.20 | 0.04 | 1.16 | 0.53 | 0.62 |
| Net Present Value | -1.25 | ||||||||
| It is not recommend to invest in this project as having negative Net Present Value. So it is not a good investment. | |||||||||
| Working Notes: | |||||||||
| (i)Net cash inflow: | ($ millions) | ||||||||
| (1) | Sales | Variable cost | Net Cash Inflow | ||||||
| 1-7 year | 3.20 | 2.00 | 1.20 | ||||||
| (ii) Annual Depreciation = $ 7 million/7 = $ 1 million | |||||||||
| (iii) Cost of capital = Risk free rate + Beta (Market rate - Risk free rate) | |||||||||
| Cost of capital = 1% + 1.2 (8% -1%) | |||||||||
| Cost of capital = 9.4 % | |||||||||
| 1b) Present worth for $ 3 million of machine shall be recover after 5 year is ($ 3 million x .64) = $ 1.92 millions | |||||||||
| 1c) Contribution = Sales - Variable cost | |||||||||
| Contribution = $ 2 - $ .50 = $ 1.50 per shoelaces | |||||||||
| Breakeven Sales in unit = Fixed cost / Contribution per unit | |||||||||
| Breakeven Sales in unit = $ 7 millions / $ 1.50 per shoelaces | |||||||||
| Breakeven Sales in unit = $ 46,66,667 shoelaces | |||||||||
| 1d) EVA = Net operating profit after tax - (Invested Capital x Cost of capital) | |||||||||
| then Net operating profit after should be more that ($ 7 million x 9.4%) = $ 6,58,000 |
 ekkarill92 answered 1 year agoRelated SolutionsSpringfield Manufacturing Co. is considering the investment of $60,000 in a new machine. The machine will...Springfield Manufacturing Co. is considering the investment of
$60,000 in a new machine. The machine will generate cash flow of
$7,500 per year for each year of its 15 year life and will have a
salvage value of $4,000 at the end of its life. Springfield's cost
of capital is 10%. (a.) Calculate the net present value of the
proposed investment. Ignore income taxes, and round all answers to
the nearest $1. (b.) Calculate the present value ratio of the...
Northern Manufacturing Ltd. is considering the investment of $85,000 in a new machine. The machine will...Northern Manufacturing Ltd. is considering the investment of
$85,000 in a new machine. The machine will generate cash flow of
$14,000 per year for each year of its eight-year life and will have
a salvage value of $9,000 at the end of its life. The company’s
cost of capital is 10%. Table 6-4 and Table 6-5. (Use appropriate
factor(s) from the tables provided. Round the PV factors to 4
decimals.)
Required: Calculate the net present value of the proposed
investment....
Northern Manufacturing Ltd. is considering the investment of $85,000 in a new machine. The machine will...Northern Manufacturing Ltd. is considering the investment of
$85,000 in a new machine. The machine will generate cash flow of
$14,000 per year for each year of its eight-year life and will have
a salvage value of $9,000 at the end of its life. The company’s
cost of capital is 10%. Table 6-4 and Table 6-5. (Use
appropriate factor(s) from the tables provided. Round the PV
factors to 4 decimals.)
Required:
Calculate the net present value of the proposed investment....
Springfield Manufacturing Co. is considering the investment of $60,000 in a new machine. The machine will...Springfield Manufacturing Co. is considering the investment of
$60,000 in a new machine. The machine will generate cash flow of
$7,500 per year for each year of its 15 year life and will have a
salvage value of $4,000 at the end of its life. Springfield's cost
of capital is 10%.
(a.) Calculate the net present value of the proposed investment.
Ignore income taxes, and round all answers to the nearest $1.
(b.) Calculate the present value ratio of the...
Roten Manufacturing Company is considering an investment on a machine for producing auto parts. The machine...Roten Manufacturing Company is considering an investment on a
machine for producing auto parts. The machine costs $250,000 today,
will have a five-year life and will be depreciated over a five-year
life on a straight-line basis toward a zero salvage value. The
company paid a consulting company $7,000 last year to help them
decide whether there is a sufficient demand for the auto parts. In
addition to the investment on the machine, the company also invests
$15,000 in net working...
"A manufacturing company is considering a new investment in a machine that will cost $170,000 and..."A manufacturing company is considering a new investment in a
machine that will cost $170,000 and has a maintenance cost of
$5,700 that occurs every 2 years starting at the end of year 2.
Assuming that this equipment will last infinitely under these
conditions, what is the capitalized equivalent cost of this
investment at the rate of 13.6%? Enter your answer as a positive
number."
Question 1 "A manufacturing company is considering a new investment in a machine that will cost...Question 1
"A manufacturing company is considering a new investment in a
machine that will cost $142,000 and has a maintenance cost of
$6,600 that occurs every 2 years starting at the end of year 2.
Assuming that this equipment will last infinitely under these
conditions, what is the capitalized equivalent cost of this
investment at the rate of 13.3%?
Integrativelong dash—Investment decision Holliday Manufacturing is considering the replacement of an existing machine. The new machine...Integrativelong dash—Investment decision
Holliday Manufacturing is considering the replacement of an
existing machine. The new machine costs $1.18 million and requires
installation costs of $159,000.The existing machine can be sold
currently for $186,000 before taxes. It is 2 years old, cost
$803,000 new, and has a $385,440 book value and a remaining useful
life of 5 years. It was being depreciated under MACRS using a
5-year recovery period and therefore has the final 4 years of
depreciation remaining. If it...
(a) The manufacturing firm Rebo is considering a new capital investment project. The project will last...(a) The manufacturing firm Rebo is considering a new capital
investment project. The project will last for five years. The
anticipated sales revenue from the project is $3 million in year 1
and $4.2 million in each of years 2 – 5. The cost of materials and
labour is 50% of sales revenue and other expenses are $1 million in
each year. The project will require working capital investment
equal to 20% of the expected sales revenue for each year....
The manufacturing firm Rebo is considering a new capital investment project. The project will last for...The manufacturing firm Rebo is considering a new capital
investment project. The project will last for five years. The
anticipated sales revenue from the project is $3 million in year 1
and $4.2 million in each of years 2 – 5. The cost of materials and
labour is 50% of sales revenue and other expenses are $1 million in
each year. The project will require working capital investment
equal to 20% of the expected sales revenue for each year. This...
ADVERTISEMENT
ADVERTISEMENT
Latest Questions
ADVERTISEMENT
|