Question

FIN 331 – Homework – Capital Budgeting and Cash Flows Your firm is considering replacing a machine that originally cost $275,000 with a new machine costing $340,000. It will also cost $10,000 to install the new machine. The new machine has a much higher output and would increase sales by $110,000 each year. The new machine is also more efficient and will save $10,000 in operating costs annually. The new machine would take more floor space causing the firm to cease leasing a portion of it plant at $15,000 per year. The new machine will be depreciated under the three year MACRS class over a three-year project life. The new equipment will increase inventories by $8,000 and increase accounts payable by $15,000. The old equipment being replaced can be sold today for $50,000. The old machine was being depreciated using MACRS three-year life and had been used for three years. Other important information for your decision is as follows. The firm’s tax rate is 30%. The firm’s cost of capital is 8%. At the end of the three-year use of the new equipment, the equipment can be sold for $70,000. What are the project’s cash flows? A. The total cost of the new asset = $275,000+$10,000=$285,000. B. Change in Net Working Capital = $15,000-$8000 = $7,000 C. Net Cash flow from sale of old asset initial investment = 50,000 + ($-30,750).30= $40,775 D. Change in revenues =$110,000 - $15,000 = $95,000 E. Change in operating costs = decrease cost by $10,000 per year F. Year Decreciation Expense (new) 1 $350,000 x .33=$115,500 2 $350,000 x .45=$157,500 3 $350,000 x .15=$52,500 4 $350,000 x .07=$24,500 Old depreciation Year Deprciation 1 $275,000 x .33=$90,750 2 $275,000 x .45=$123,750 3 $275,000 x .15=$41,250 4 $275,000 x .07=$19,250 (115,500 – 41,250) = 74,250 year 1 (157,500 – 19,250) = 138,248 year 2 (41,250) = year 3 chenge in tax year 1=9225 year 2=9974 year 3=19,125

Answer 1

Initial Outflow:
Cost of Machinery	$3,40,000
Installation	$10,000
Revenue/Expense Changes:
Increase in Sales	$1,10,000
Savings in Operating Costs	$10,000
Loss of Leasing Revenue	-$15,000
Sale of Machinery (after Year 3)	$70,000
Changes in Working Capital
Increase in Inventories	-$8,000
Increase in Payables	$15,000
Depreciation Schedule
	Year 0	Year 1	Year 2	Year 3	Year 4
Depreciation Rate		33%	44%	15%	7%
Depreciation Amount		116655	155575	51835	25935
		(350000*33%)- same for all years
Income Statement:		Year 1	Year 2	Year 3	Year 4
Revenue		$1,05,000	$1,05,000	$1,05,000	$70,000
Depreciation		116655	155575	51835	25935
Profit Before Tax (Revenue- Depreciation)		-$11,655	-$50,575	$53,165	$44,065
Tax (PBT*Tax Rate)		-$3,496.50	$0.00	$15,949.50	$13,219.50
Profit after Tax (PBT-Tax)		$0	$0	$37,216	$30,846
Note 1: Increase in revenue (110000)+ Savings in cost (10000)- Loss of Leasing Revenue (15000) = $105000
Cash Flow	Year 0	Year 1	Year 2	Year 3	Year 4
Initial Outflow	-350000
Profit after Tax		$0.00	$0.00	$37,215.50	$30,845.50
Depreciation		116655	155575	51835	25935
Increase in Inventories		-$8,000	-$8,000	-$8,000
Increase in Payables		$15,000	$15,000	$15,000
Cash Flow	-350000	123655	162575	96050.5	56780.5