Question

Use the information provided below on Ford Motor Company to answer the following four parts:

Ford Motor Company (F) is considering replacing an old automated assembly line with a new one that will cost $200,000. Delivery charges on the new machine are expected to be $5,000, while installation/modification charges are anticipated to be $10,000. The new machine is expected to increase annual before-tax revenues by $75,000 and fixed costs by $10,000. The replacement machine will be depreciated using MACRS 3-year class (33%, 45%, 15%, 7%), and could be sold after 3 years for $30,000. The old assembly line still has two years of depreciation left ($5,000 per year) and can be sold today for $10,000. The firm’s WACC is 10%, and its marginal tax rate is 40%.

a) What is the initial cash outflow for the replacement project?

-$200,000

-$215,000

-$210,000

-$205,000

None of the above

b) What is the depreciation outlay in the first year?

$70,950

$5,000

$65,950

$91,750

None of the above

c) What is the operating cash flow in the third and final year?

$51,900

$75,920

$75,700

$65,000

None of the above

d) What is the net present value (NPV) and should the company replace the old assembly machine?

44,008.41, Accept

$25,961.83, Accept

-$44,008.41, Reject

-$25,961.83, Reject

None of the above

Answer 1

a. Initial outlay:
Cost of new machine	-200,000
Add:
Delivery charges	-5,000
Modification charges	-10,000
Total Value of new machine	-215,000
Less:
Salvage value net of tax for old machine (WN-1)	10,000
Initial cash outflow	-205,000

b. Depreciation schedule
Year	Depreciation Rate	Depreciation = 215000*Rate for the year
1	33%	70,950
2	45%	96,750
3	15%	32,250
4	7%	15,050
Depreciation outlay in first year = 70,950

c. Operating cash flows
Year	1	2	3
Increase in annual revenues	75,000	75,000	75,000
Less: Increase in fixed costs	-10,000	-10,000	-10,000
Less: Incremental Depreciation (WN-2)	-65,950	-91,750	-32,250
Incremental Profit before tax	-950	-26,750	32,750
Less: Tax @ 40%	-380	-10,700	13,100
Incremental Profit after tax	-570	-16,050	19,650
Add: Depreciation	65,950	91,750	32,250
Operating cash flow	65,380	75,700	51,900
Operating cash flow in third/final year = 51,900

d. NPV
Year	0	1	2	3
Initial cash outflow	-205,000
Operating cash flows		65,380	75,700	51,900
Sale net of tax new machine (WN-3)				24,020
Net cash flows	-205,000	65,380	75,700	75,920
PVF @ 10%	1.0000	0.9091	0.8264	0.7513
PV	-205,000	59,436	62,562	57,040
NPV	-25,961.83

Since NPV is negetive, reject the project. WN-1: Salvage value net of tax for old machine
Book value = 5000*2	10,000
Sale value	10,000
Net profit	0
Sale value, net of tax	10,000

WN-2: Incremental Depreciation
Year	Depreciation on new machine	Depreciation on old machine	Incremental Depreciation
1	70,950	5,000	65,950
2	96,750	5,000	91,750
3	32,250	0	32,250

WN-3: Salvage value net of tax for new machine
Purchase price	215,000
Less: Depriciatin in 3 years	199,950
Book value in Y=3	15,050
Sale value	30,000
Net profit	14,950
Tax @40%	5,980
Sale value, net of tax	24,020

Kindly give a thumbs up!!