Question

 

Macon Company is considering a new assembly line to replace the existing assembly line. The existing assembly line was installed 3 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 6 more years. The new assembly line costs $120,000; requires $9,000 in installation costs and $5,000 in training fees; it has a 6-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 $10,000. At the end of 6 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 20% taxes and its shareholders require 10% return.

(A) (9 points) What is the initial cash outlay for this replacement project?

(B) (3 points) What is the operating cash flow of the project?

(C) (5 points) What is the terminal cash flow of the project?

(D) (3 points) Should you replace the existing assembly line? Provide all the details.

Answer 1

1-
Initial cost outlay				cost of old equipment		90000
cost of new equipment		-120000		Accumulated depreciation =(90000/6)*3		45000
Installation cost		-9000		Book value at the end of year 3		45000
training fees		-5000		loss on sale of existing equipment	45000-15000	30000
sale proceed of existing equipment with tax credit		21000		tax credit on loss on sale of equipment	30000*20%	6000
investment in net working capital =(5000-10000)		-5000		sale proceed of existing equipment with tax credit	15000+6000	21000
total cash outlay		-118000
2-
operating cash flow
Year		1	2	3	4	5	6
Incremental sales revenue		10000	10000	10000	10000	10000	10000
savings from reduction of production expenses		5000	5000	5000	5000	5000	5000
total annual savings		15000	15000	15000	15000	15000	15000
Less differential depreciation = (new depreciation-old depreciation)	(129000/6) -(90000/6) from year 1-3 and 129000/6 =21500	6500	6500	6500	21500	21500	21500
incremental operating profit		8500	8500	8500	-6500	-6500	-6500
less taxes-20%		1700	1700	1700	-1300	-1300	-1300
after tax incremental profit		6800	6800	6800	-5200	-5200	-5200
add incremental depreciation		6500	6500	6500	21500	21500	21500
operating cash flow		13300	13300	13300	16300	16300	16300
3-
Terminal cash flow
Year		5
after tax sale proceeds of new equipment =15000*(1*.20)		12000
recovery of working capital		5000
terminal cash flow		17000
4-
Year	0	1	2	3	4	5	6
total cash outlay	-118000
operating cash flow		13300	13300	13300	16300	16300	16300
terminal cash flow							17000
net operating cash flow	-118000	13300	13300	13300	16300	16300	33300
present value factor at 10% =1/(1+r)^n r =10%	1	0.909091	0.826446	0.751315	0.683013	0.620921	0.564474
present value of net operating cash flow	-118000	12090.91	10991.74	9992.487	11133.12	10121.02	18796.98
Net present value = sum of present value net operating cash flow	-44873.7
No equipment should not be replaced as it results in negative net present value