Question

FBR Corporation has just finished minor renovations on their office building at a cost of $150,000. FBR originally allocated only $100,000 for this renovation. A memo from accounting suggests that the $50,000 cost overrun should be charged to the next new project the company will implement. As its next project, FBR Corp. is considering the acquisition of a new machine that would replace one of their old machines in use. The new machine costs $0.9 million (t=0), and it can be sold at the end of its expected 4-year operating life for $300,000. The new machine takes up more space and GEC will need to move maintenance and cleaning supplies that used to be stored next to the machine to a small storage room that could otherwise be sublet for $25,000 a year (at t=1 to t=4). The old machine was bought 8 years ago for $800,000 and can be sold for $300,000 today or for $150,000 in 4 years. FBR paid $25,000 for a study which indicates that the new machine will reduce manufacturing costs by $220,000 annually. Moreover, net working capital will be reduced by $150,000 when the new machine is installed, and will increase again by $150,000 at the end of the machine’s operating life. Both machines belong to asset class 43 with a CCA rate of 30%. FBR’s marginal tax rate is 40%, and it uses a discount rate (required rate of return, RRR) of 14% to evaluate projects of this nature. a) What is the initial cash outlay (the total cash flow at t=0)? b) What is the first year’s cash flow (excluding the CCA Tax Shield)? c) What is the last year’s cash flow (excluding the CCA Tax Shield)? d) What is the year 3 CCA? e) What is the PV CCA Tax Shield? f) What is the NPV of the replacement project? g) Should FBR Corp. replace the old machine with the new one?

Answer 1

a) What is the initial ash outlay (the total cash flow at t=0)?

Particulars	Amount ($)
Cost Overrun	-50,000
Acquisition Cost	-900,000
Old machine Selling Price	300,000
Study cost	-25,000
TOTAL (t=0)	-675,000

b) What is the first year's cash flow (excluding CCA Tax Shield)?

Particulars	Amount ($)
Manf. Cost Savings	220,000
NWC Savings	150,000
TOTAL SAVINGS	370,000
Storage Cost	25,000
CCA	270,000
TOTAL Expense	295,000
Cash Flow (t=1)	75,000

The cash flow excluding CCA tax shield is (75000+270,000) $345,000/-

c) What is the last year’s cash flow (excluding the CCA Tax Shield)?

Particulars	Amount ($)
Manf. Cost Savings	220,000
NWC Savings	150,000
TOTAL SAVINGS	370,000
SALVAGE INCOME	300,000
TOTAL INCOME	670,000
Storage Cost	25,000
Expense	25,000
CCA	92,610
Cash Flow (t=4)	552,390

d) What is the year 3 CCA?

The CCA Schedule is as under:

T	UCC	CCA
1	900,000	270,000
2	630,000	189,000
3	441,000	132,300
4	308,700	92,610

e) What is the PV CCA Tax Shield?

T	CCA	PV @ 14%
1	270,000	236,842.11
2	189,000	145,429.36
3	132,300	89,298.73
4	92,610	54,832.55
TOTAL		526,402.75

Only 4 questions to be answered. I've answered 5.