Question

Your corporation is considering replacing older equipment. The old machine is fully depreciated and cost $51800 seven years ago. The old equipment currently has no market value. The new equipment cost $63100. The new equipment will be depreciated to zero using straight-line depreciation for the four-year life of the project. At the end of the project the equipment is expected to have a salvage value of $37500. The new equipment is expected to save the firm $29000 annually by increasing efficiency and cost savings. The corporation has tax rate of 31% and a required return on capital of 13%.

a. What is the total initial cash outflow? (Show your answer to the nearest dollar as a negative number without commas or decimals.)

b. What are the estimated annual operating cash flows? (nearest dollar)

c. What is the terminal cash flow? (nearest dollar)

d. What is the NPV for this project? (nearest dollar)

Answer 1

a)The initial cash outflow of the project=Purchase of new machinery +installation+/- increase or decrease in working capital+net proceeds from sale of old asset +/- tax effect due to sale of old asset=initial cashflow

In the given question the old asset has no market value and is fully depreciated so book value(purchase price -accumulated depreciation) is zero.The purchase price of new equipment=$63,100 therefore initial outflow =-$63100

b)Estimated Annual operating cashflow=Increase or decrease in operating revenue+/-increase ore decrease in expense +/- tax deprecation charges =net change in income before tax +/-net increase or decrease in tax =Net effect after tax +/-net increase or decrease in tax depreciation charges =After tax cashflow

Here the annual savings =$29,000 depreciation per year =$63100/4=$15,775 per year

Estimated Annual operating cashflow =$29,000 less tax depreciation=$15,775=$13,225 Less tax @31% (4099.75) We get net effect after tax as $9125.25 Add back tax depreciation charrges 15,775 we get After tax cashflow =$24,900.25 his will be the same for years 1 to 3

This is the same for Year 1 ,2and 3

During the final year there will be terminal cashflow .Terminal Cashflow =Salvage value -Tax applicable+Any change in Working Capital

Salvage value =$37,500 Tax @31%=$11,625 Terminal cashflow =$37,500-$11,625 =$25,875

So year 4 cashflow =$24,900.25+$25,875=$50,775.25

c)Terminal Cashflow =Salvage value -Tax applicable+ Any change in working capital.Book value =0 since asset is fully depreciated

Salvage value =$37,500 Tax @31%=$11,625 Terminal cashflow =$37,500-$11,625 =$25,875

d)NPV =Total PV of inflows -initial outflow Initial outflow =$63,100 Discount rate =13%

Pv of inflows =$24,900.25*.885=$22036.721 + $24,900.25*.7831=$19499.385 +$24,900.25*.6931=$17258.36 + $50,775.25*.6133=$31140.46 Total PV of inflow = $89,934.926 NPV =$89,934.926-63,100=$26384.926