Question
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The Lathe You are considering the purchase of a new lathe to expand production of a...
- The Lathe
You are considering the purchase of a new lathe to expand production of a hot product line. The lathe costs $280. It will have a life of four years. You will depreciate the lathe to zero book value using straight-line depreciation over four years. At the end of four years, you will sell the machine for $50. The new lathe will generate cash sales of $230 per year, and operating costs will run $120 per year. The firm will need to carry additional inventory of $30, accounts receivable of $30, and cash balances of $10. There is no material impact on accounts payable. The corporate tax rate is 40%. Assume the additional working capital requirements are incurred at the start of the project (t = 0) and are recovered in Year 4. The discount rate is 8%.
Assume all cash flows last for four years.
- Use a table similar to the following to estimate the total cash flows from the project.
|
Description |
0 |
1 |
2 |
3 |
4 |
- Assume the cash flows from (A) are the following:
|
Description |
0 |
1 |
2 |
3 |
4 |
|
Total cash flow |
‒375.00 |
100.00 |
100.00 |
100.00 |
200.00 |
What are the NPV and IRR for the project? (Show calculations to receive full credit.) Should you invest in the project?
Solutions
Expert Solution
| Tax rate | 40% | ||||||
| Calculation of annual depreciation | |||||||
| Depreciation | Year-1 | Year-2 | Year-3 | Year-4 | Total | ||
| Cost | $ 280 | $ 280 | $ 280 | $ 280 | |||
| Dep Rate | 25.00% | 25.00% | 25.00% | 25.00% | |||
| Depreciation | Cost * Dep rate | $ 70 | $ 70 | $ 70 | $ 70 | $ 280 | |
| Calculation of after-tax salvage value | |||||||
| Cost of machine | $ 280 | ||||||
| Depreciation | $ 280 | ||||||
| WDV | Cost less accumulated depreciation | $ - | |||||
| Sale price | $ 50 | ||||||
| Profit/(Loss) | Sale price less WDV | $ 50 | |||||
| Tax | Profit/(Loss)*tax rate | $ 20 | |||||
| Sale price after-tax | Sale price less tax | $ 30 | |||||
| Calculation of annual operating cash flow | |||||||
| Year-1 | Year-2 | Year-3 | Year-4 | ||||
| Sale | $ 230 | $ 230 | $ 230 | $ 230 | |||
| Less: Operating Cost | $ 120 | $ 120 | $ 120 | $ 120 | |||
| Contribution | $ 110 | $ 110 | $ 110 | $ 110 | |||
| Less: Depreciation | $ 70 | $ 70 | $ 70 | $ 70 | |||
| Profit before tax (PBT) | $ 40 | $ 40 | $ 40 | $ 40 | |||
| Tax@40% | PBT*Tax rate | $ 16 | $ 16 | $ 16 | $ 16 | ||
| Profit After Tax (PAT) | PBT - Tax | $ 24 | $ 24 | $ 24 | $ 24 | ||
| Add Depreciation | PAT + Dep | $ 70 | $ 70 | $ 70 | $ 70 | ||
| Cash Profit after-tax | $ 94 | $ 94 | $ 94 | $ 94 | |||
| Calculation of working capital movement | |||||||
| Increase in AR | $ 30 | ||||||
| Increase in Cash | $ 10 | ||||||
| Increase in inventory | $ 30 | ||||||
| Total working capital | $ 70 | ||||||
| Calculation of Cash flow | |||||||
| Year | Capital | Working capital | Operating cash | Annual Cash flow | |||
| 0 | $ (280) | $ (70) | $ (350) | ||||
| 1 | $ 94 | $ 94 | |||||
| 2 | $ 94 | $ 94 | |||||
| 3 | $ 94 | $ 94 | |||||
| 4 | $ 30 | $ 70 | $ 94 | $ 194 | |||
| Calculation of NPV | |||||||
| 8.00% | |||||||
| Year | Annual Cash flow | PV factor, 1/(1+r)^time | Present values | ||||
| 0 | $ (375) | 1.0000 | $ (375) | ||||
| 1 |
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