Question

In: Finance

Marian runs a store selling decorative breathing masks. For obvious reasons, she has recently seen a...

Marian runs a store selling decorative breathing masks. For obvious reasons, she has recently seen a sharp uptick in business and wants to increase her production capacity. To accomplish this, she wants to buy a new industrial sewing machine, which will allow her to increase her yearly EBIT by $15,000 per year for the next 4 years. The sewing machine costs $36,000, but if she makes this purchase, she will borrow $28,000 for 4 years at 6.5% to help pay the purchase price. Her tax rate is 36%, and her cost of levered equity is 15%.

2A. What is the NPV of buying the new sewing machine if Marian pays cash?

2B. Using the FTE method, what is the NPV of buying the new sewing machine if Marian takes out the loan?

Solutions

Expert Solution

Marian runs a store selling decorative breathing masks. For obvious reasons, she has recently seen a sharp uptick in business and wants to increase her production capacity. To accomplish this, she wants to buy a new industrial sewing machine, which will allow her to increase her yearly EBIT by $15,000 per year for the next 4 years. The sewing machine costs $36,000, but if she makes this purchase, she will borrow $28,000 for 4 years at 6.5% to help pay the purchase price. Her tax rate is 36%, and her cost of levered equity is 15%.

2A. What is the NPV of buying the new sewing machine if Marian pays cash?

2B. Using the FTE method, what is the NPV of buying the new sewing machine if Marian takes out the loan?

Answer 2A -

The NPV of the new sewing machine, if Marian pays cash will be computed as below:

Period Cash Flow Tax @ 36% Net CFAT Factor used Factor PV
Initial Investment ($36,000) $0 ($36,000) 1.00 ($36,000)
Years 1-4 $15,000 $5,400 $9,600 PVAF (15%,4 yrs) 2.855 $27,408
Net Present Value ($8,592)

Thus, purchasing the machine has a negative NPV, if brought outright with cash.

Note : Since no information has been provided regarding the depreciation of the machine, or its possible salvage value after 4 years, these and their available tax shield has been ignored.

Answer 2B -

The NPV of the new sewing machine, if Marian pays takes out the loan will be computed as below:

Particulars Amount
EBIT per year $15,000
Less: Interest ($28,000*6.5%) ($1,820)
Earnings before taxes $13,180
Less: Taxes @ 36% ($4,745)
Earnings after taxes (CFAT) $8,435
PVAF (15%, 4 years) 2.855
PV of CFAT (Gross flow to equity) $24,082
Less: Initial Investment ($36,000)
NPV (Net flow to equity) ($11,918)

Thus, purchasing the machine has a negative NPV, as per the FTE method, even if a loan is used for purchasing it.


Related Solutions

Marian runs a store selling decorative breathing masks. For obvious reasons, she has recently seen a...
Marian runs a store selling decorative breathing masks. For obvious reasons, she has recently seen a sharp uptick in business and wants to increase her production capacity. To accomplish this, she wants to buy a new industrial sewing machine, which will allow her to increase her yearly EBIT by $15,000 per year for the next 4 years. The sewing machine costs $36,000, but if she makes this purchase, she will borrow $28,000 for 4 years at 6.5% to help pay...
Marian runs a store selling decorative breathing masks. For obvious reasons, she has recently seen a...
Marian runs a store selling decorative breathing masks. For obvious reasons, she has recently seen a sharp uptick in business and wants to increase her production capacity. To accomplish this, she wants to buy a new industrial sewing machine, which will allow her to increase her yearly EBIT by $15,000 per year for the next 4 years. The sewing machine costs $36,000, but if she makes this purchase, she will borrow $28,000 for 4 years at 6.5% to help pay...
A 60-year-old female has been recently diagnosed with a right-sided stroke. She is being seen in...
A 60-year-old female has been recently diagnosed with a right-sided stroke. She is being seen in the stroke clinic for a follow-up appointment. a.    What teaching components would be important to alert this patient to, related to her medical diagnosis? b.    What areas of health promotion should be emphasized with this patient?
In the wake of COVID-19, the Hand Sanitizer and Masks market has seen much higher prices....
In the wake of COVID-19, the Hand Sanitizer and Masks market has seen much higher prices. What shift in demand or supply is most likely to explain this outcome? Sketch a demand and supply diagram and explain your reasoning for each. A rise in demand A fall in demand A rise in supply A fall in supply
Ichabod runs a clothing store in London. He recently purchased 1000 dress shirts that had a...
Ichabod runs a clothing store in London. He recently purchased 1000 dress shirts that had a manufacturer’s list price of $35. On each shirt there was a trade discount of 10%, 8% and 6% from the manufacturer. Ichabod’s store has operating expenses that are 35% of the selling price and rate of markup is 60% on selling price.   a) He sold 400 shirts at the regular selling price. What was the total revenue from the first 400 shirts sold? b)...
Marisa Williams runs a retail grocery store and purchases items for resale to her customers. She...
Marisa Williams runs a retail grocery store and purchases items for resale to her customers. She is facing an ordering decision about how much of a particular item to purchase at one time.. in order t take advantage of supplier discounts (if it makes sense to do so). Demand = 36,000 units per year order cost = $25 per order Carrying cost = $0.45 per unit purchasing price = $0.85 Discount price= $0.82 (if buy a minimun of 6,000 units...
Emma runs a business selling scarves. She purchases the scarves directly from scarf makers in Cambodia...
Emma runs a business selling scarves. She purchases the scarves directly from scarf makers in Cambodia and sells them in makers markets in Victoria. The following transactions have taken place during the 2019/20 income year. Please advise Emma as to the tax consequences of each of these transactions (from (a)-(d)), referring where appropriate to legislation in your answer: (a) Emma purchased $3,000 of scarves on 5 July 2019 from a scarf maker in Cambodia. The scarves were loaded onto a...
Case study Alana is entering the end-of-life stage. She often has difficulty breathing. She likes Mai...
Case study Alana is entering the end-of-life stage. She often has difficulty breathing. She likes Mai to stroke her arm and apply massage oil. One morning she whispers to Mai that she doesn’t have the energy to see her friends and extended family anymore. She asks if Mai can tell them that she loves them, but she can’t see them anymore. As Mai is helping her out of bed, Alana says, ‘I don’t think I can have a shower today’....
A 25-year-old woman has a 2-month history of difficulty in breathing and extreme fatigue. She has...
A 25-year-old woman has a 2-month history of difficulty in breathing and extreme fatigue. She has been on a “fad” diet for the past 6 months. Physical examination revealed no enlargement of the spleen or liver. Laboratory data are: Hemoglobin: 6.0 g/dL Hematocrit: 18% White cell count: 3.3 × 109/L White cell differential: Neutrophils: 10% Lymphocytes: 80% Monocytes: 10% Eosinophils, basophils: 0% Red cell count: 2.00 × 1012/L RDW: 12 Reticulocyte count: 0.6% Questions: 1. This patient’s MCV is ___...
Sarah has a BMR of 1775 and ingests, on average, 2390 kcals daily. She runs on...
Sarah has a BMR of 1775 and ingests, on average, 2390 kcals daily. She runs on the treadmill every day right after class for 45 minutes at 6.5mph, 3% grade. If she continues to follow her current eating and exercise regimen, will she likely lose weight, maintain her weight or gain weight? Her current weight is 70kg.
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT