Question

Dublin Chips is a manufacturer of prototype chips based in​ Buffalo, New York.

Next​ year, in 2018​, Dublin Chips expects to deliver 615 prototype chips at an average price of $95,000. Dublin ​Chips' marketing vice president forecasts growth of 65 prototype chips per year through 2024.

That​ is, demand will be 615 in 2018​, 680 in 2019​, 745 in 2020​, and so on. The plant cannot produce more than 585 prototype chips annually. To meet future​ demand, Dublin Chips must either modernize the plant or replace it. The old equipment is fully depreciated and can be sold for $4,200,000 if the plant is replaced. If the plant is​ modernized, the costs to modernize it are to be capitalized and depreciated over the useful life of the updated plant. The old equipment is retained as part of the modernize alternative.

The following data on the two options are​ available:

	Modernize		Replace
Initial investment in 2018	$35,300,000		$66,300,000
Terminal disposal value in 2024	$7,500,000		$16,000,000
Useful life	7 years		7 years
Total annual cash operating cost per prototype chip	$78,500		$66,000

Dublin Chips uses​ straight-line depreciation, assuming zero terminal disposal value. For​ simplicity, we assume no change in prices or costs in future years. The investment will be made at the beginning of 2018​, and all transactions thereafter occur on the last day of the year. Dublin ​Chips' required rate of return is 14​%. There is no difference between the modernize and replace alternatives in terms of required working capital. Dublin Chips pays a 35​% tax rate on all income. Proceeds from sales of equipment above book value are taxed at the same 35​% rate.

1.	Calculate the​ after-tax cash inflows and outflows of the modernize and replace alternatives over the 2018 -2024 period.
2.	Calculate the net present value of the modernize and replace alternatives.
3.	Suppose Dublin Chips is planning to build several more plants. It wants to have the most advantageous tax position possible.Dublin Chips has been approached by​ Spain, Malaysia, and Australia to construct plants in their countries. Briefly describe in qualitative terms the income tax features that would be advantageous to Dublin Chips.

​Let's begin with the modernize alternative. Start by computing the present value of the​after-tax cash flows from​ operations, then calculate the present value of the​ after-tax cash savings from depreciation and the terminal disposal​ value, and​ finally, determine the total net present value​ (NPV) of the investment for the modernize alternative.

			Net Cash		Present Value
	PV factor		Inflow		of Cash Flows
Net initial investment
After-tax cash flows from operations:
Dec 31, 2018		x		=
Dec 31, 2019		x		=
Dec 31, 2020		x		=
Dec 31, 2021		x		=
Dec 31, 2022		x		=
Dec 31, 2023		x		=
Dec 31, 2024		x		=

Answer 1

hey, here's the NPV to modernize alternative.

Years	Demand	Sales price- cost =$95000-$78500	Gross profit	Less: depreciation	Net profit	less: Tax @ 35%	Profit after Tax	Add: Depreciation Net cash Flow	PV factor @ 14%	Present value of cash flow
31-Dec-18	615	16500	$     1,01,47,500	$ 39,71,429	$   61,76,071	$     21,61,625	$       40,14,446	$           79,85,875	0.877	$     70,05,154
31-Dec-19	680	16500	$     1,12,20,000	$ 39,71,429	$   72,48,571	$     25,37,000	$       47,11,571	$           86,83,000	0.769	$     66,81,287
31-Dec-20	745	16500	$     1,22,92,500	$ 39,71,429	$   83,21,071	$     29,12,375	$       54,08,696	$           93,80,125	0.675	$     63,31,317
31-Dec-21	810	16500	$     1,33,65,000	$ 39,71,429	$   93,93,571	$     32,87,750	$       61,05,821	$        1,00,77,250	0.592	$     59,66,541
31-Dec-22	875	16500	$     1,44,37,500	$ 39,71,429	$1,04,66,071	$     36,63,125	$       68,02,946	$        1,07,74,375	0.519	$     55,95,873
31-Dec-23	940	16500	$     1,55,10,000	$ 39,71,429	$1,15,38,571	$     40,38,500	$       75,00,071	$        1,14,71,500	0.456	$     52,26,261
31-Dec-24	1005	16500	$     1,65,82,500	$ 39,71,429	$1,26,11,071	$     44,13,875	$       81,97,196	$        1,21,68,625	0.400	$     48,63,037
31-Dec-24	terminl value of machine (sold on no profit no loss basis because of SML depriciation							$           75,00,000	0.400	$     29,97,280
										$ 4,46,66,749
								Net initial investment		$ 3,53,00,000
								Net present value		$     93,66,749

Replacement :

(depreciation is calculation =(66300000-16000000)/7)

Years	Demand	Sales price- cost =$95000-$66000	Gross profit	Less: depreciation	Net profit	less: Tax @ 35%	Profit after Tax	Add: Depreciation Net cash Flow	PV factor @ 14%	Present value of cash flow
31-Dec-18	615	29000	$     1,78,35,000	$ 71,85,714	$1,06,49,286	$     37,27,250	$       69,22,036	$        1,41,07,750	0.877	$ 1,23,75,219
31-Dec-19	680	29000	$     1,97,20,000	$ 71,85,714	$1,25,34,286	$     43,87,000	$       81,47,286	$        1,53,33,000	0.769	$ 1,17,98,246
31-Dec-20	745	29000	$     2,16,05,000	$ 71,85,714	$1,44,19,286	$     50,46,750	$       93,72,536	$        1,65,58,250	0.675	$ 1,11,76,347
31-Dec-21	810	29000	$     2,34,90,000	$ 71,85,714	$1,63,04,286	$     57,06,500	$    1,05,97,786	$        1,77,83,500	0.592	$ 1,05,29,260
31-Dec-22	875	29000	$     2,53,75,000	$ 71,85,714	$1,81,89,286	$     63,66,250	$    1,18,23,036	$        1,90,08,750	0.519	$     98,72,549
31-Dec-23	940	29000	$     2,72,60,000	$ 71,85,714	$2,00,74,286	$     70,26,000	$    1,30,48,286	$        2,02,34,000	0.456	$     92,18,338
31-Dec-24	1005	29000	$     2,91,45,000	$ 71,85,714	$2,19,59,286	$     76,85,750	$    1,42,73,536	$        2,14,59,250	0.400	$     85,75,917
31-Dec-24	terminl value of machine (sold on no profit no loss basis because of SML depriciation							$        1,60,00,000	0.400	$     63,94,197
										$ 7,99,40,073
								Net initil investmemt		$ 6,21,00,000
								Net present value		$ 1,78,40,073