Question

Universal Electronics is considering the purchase of manufacturing equipment with a 10-year midpoint in its asset depreciation range (ADR). Carefully refer to Table 12–11 to determine in what depreciation category the asset falls. (Hint: It is not 10 years.) The asset will cost $140,000, and it will produce earnings before depreciation and taxes of $50,000 per year for three years, and then $24,000 a year for seven more years. The firm has a tax rate of 25 percent. Assume the cost of capital is 12 percent. In doing your analysis, if you have years in which there is no depreciation, merely enter a zero for depreciation. Use Table 12–12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

Answer 1

Annual operating cash flows
Ref	Particulars		Year 1	Year 2	Year 3	year 4	year 5	year 6	year 7	year 8	year 9	year 10
a	Operating cash flow		$       50,000.00	$               50,000.00	$   50,000.00	$   24,000.00	$   24,000.00	$   24,000.00	$   24,000.00	$   24,000.00	$   24,000.00	$   24,000.00
b	Depreciation		$       20,006.00	$               34,286.00	$   24,486.00	$   17,486.00	$   12,502.00	$   12,488.00	$   12,502.00	$     6,244.00	$                 -	$                 -
c=a-b	Profit before tax		$       29,994.00	$               15,714.00	$   25,514.00	$     6,514.00	$   11,498.00	$   11,512.00	$   11,498.00	$   17,756.00	$   24,000.00	$   24,000.00
	Less: taxes		$         7,498.50	$                 3,928.50	$     6,378.50	$     1,628.50	$     2,874.50	$     2,878.00	$     2,874.50	$     4,439.00	$     6,000.00	$     6,000.00
	Profit after tax		$       22,495.50	$               11,785.50	$   19,135.50	$     4,885.50	$     8,623.50	$     8,634.00	$     8,623.50	$   13,317.00	$   18,000.00	$   18,000.00
	Add: depreciation		$       20,006.00	$               34,286.00	$   24,486.00	$   17,486.00	$   12,502.00	$   12,488.00	$   12,502.00	$     6,244.00	$                 -	$                 -
	Cash flow after tax		$       42,501.50	$               46,071.50	$   43,621.50	$   22,371.50	$   21,125.50	$   21,122.00	$   21,125.50	$   19,561.00	$   18,000.00	$   18,000.00
d	Present value factor@ 12.0%		0.892857143	0.797193878	0.711780248	0.635518078	0.567426856	0.506631121	0.452349215	0.403883228	0.360610025	0.321973237
e=c*d	Present value of annual cashflows		$       37,947.77	$               36,727.92	$   31,048.92	$   14,217.49	$   11,987.18	$   10,701.06	$     9,556.10	$     7,900.36	$     6,490.98	$     5,795.52
	Total present value of annual cash inflows		$     172,373.30
	Less: investment		$     140,000.00
	NPV		$       32,373.30

Depreciation:

Depreciation		Year 1	Year 2	Year 3	year 4	year 5	year 6	year 7	year 8
Asset cost		$           140,000	$                  140,000	$      140,000	$      140,000	$      140,000	$      140,000	$      140,000	$      140,000
× depreciation rate		14.29%	24.49%	17.49%	12.49%	8.93%	8.92%	8.93%	4.46%
Depreciation		$             20,006	$                    34,286	$        24,486	$        17,486	$        12,502	$        12,488	$        12,502	$           6,244

Decision is accept project as NPV is positive.