Question

Shade Your Eyes, Inc. makes sunglasses that cost $115 per pair. They want to buy equipment necessary to reduce their costs by $1 per pair.  It will cost $350,000 and will be depreciated on a straight-line basis over the 6-year life of the machine.   There is no increase in Net Working Capital for this project.  The margin before is $310,900, and with the new machine it will increase to $475,100.

The required return is 15%, and the tax rate is 40%.

You want to determine if you should buy this new equipment.

11) What is the change in Operating Cash Flow (OCF) (6 points)?

round to nearest dollar.

Answer 1

Steps

• We find the cashflows for each year.
• We discount each year cashflow with discount factor.
• We find the present value and then we sum it.
• Based on which we take our decision.

Cashflow Year 0 = Capital Outlay = 350000

Cashflow Year 1- 6 = Net Increase in Margin * (1- Tax Rate) + Tax Benefit of depreciation

= (475100 - 310900) * (1- 0.4)+ 350000/6*0.4

= 121853.33

Discount Factor Each Year = 1/(1+R)^N

for eg year 1 = 1/(1+15%)^1 = 0.8696

		13%
Year	CF	DF	PV
0	-350000	1.0000	-3,50,000.00
1	121853.3	0.8696	1,05,959.42
2	121853.3	0.7561	92,138.62
3	121853.3	0.6575	80,120.54
4	121853.3	0.5718	69,670.04
5	121853.3	0.4972	60,582.64
6	121853.3	0.4323	52,680.56
	Total		1,11,151.82

As NPV is positive, we select the project.