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 $210,000, and it will produce earnings before depreciation and taxes of $70,000 per year for three years, and then $34,000 a year for seven more years. The firm has a tax rate of 36 percent. Assume the cost of capital is 14 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.

a. Calculate the net present value. (Do not round intermediate calculations and round your answer to 2 decimal places.)
  

b. Based on the net present value, should Universal Electronics purchase the asset?

• Yes

• No

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		70,000	70,000	70,000	34,000	34,000	34,000	34,000	34,000	34,000	34,000
b	Depreciation		30,009	51,429	36,729	26,229	18,753	18,732	18,753	9,366	-	-
c=a-b	Profit before tax		39,991.00	18,571.00	33,271.00	7,771.00	15,247.00	15,268.00	15,247.00	24,634.00	34,000.00	34,000.00
	Less: taxes		14,396.76	6,685.56	11,977.56	2,797.56	5,488.92	5,496.48	5,488.92	8,868.24	12,240.00	12,240.00
	Profit after tax		25,594	11,885	21,293	4,973	9,758	9,772	9,758	15,766	21,760	21,760
	Add depreciation		30,009	51,429	36,729	26,229	18,753	18,732	18,753	9,366	-	-
	Cash flow after tax		55,603	63,314	58,022	31,202	28,511	28,504	28,511	25,132	21,760	21,760
d	Present value factor@ 14.0%		0.877192982	0.769467528	0.674971516	0.592080277	0.519368664	0.455586548	0.399637323	0.350559055	0.307507943	0.26974381
e=c*d	Present value of annual cashflows		48,774.77	48,718.41	39,163.49	18,474.35	14,807.76	12,985.82	11,394.09	8,810.17	6,691.37	5,869.63
	Total present value of annual cash inflows		$     215,689.86
	Less: investment		$     210,000.00
	NPV		$         5,689.86

NPV is 5,689.86

b

Yes