Question

Use the computerized model in File C10 to work this problem.

Golden State Bakers, Inc. (GSB) has an opportunity to invest in a new bread-making machine. GSB needs more productive capacity, so the new machine will not replace an existing machine. The new machine is priced at $260,000 and will require modifications costing $15,000. It has an expected useful life of 10 years, will be depreciated using the MACRS method over its 5-year class life, and has an expected salvage value of $12,500 at the end of Year 10. (See Table 10A.2 for MACRS recovery allowance percentages.) The machine will require a $22,500 investment in net working capital. It is expected to generate additional sales revenues of $125,000 per year, but its use also will increase annual cash operating expenses by $55,000. GSB’s required rate of return is 10 percent, and its marginal tax rate is 40 percent. The machine’s book value at the end of Year 10 will be $0, so GSB will have to pay taxes on the $12,500 salvage value.

a.   What is the NPV of this expansion project? Should GSB purchase the new machine?

b.   Suppose GSB’s required rate of return is 12 percent rather than 10 percent. Should the new machine be purchased in this case?

c.   Should GSB purchase the new machine if it is expected to be used for only five years and then sold for $31,250? (Note that the model is set up to handle a five-year life; you need enter only the new life and salvage value.)

d.   Would the machine be profitable if revenues increased by only $105,000 per year? Assume everything else is as originally presented and evaluated in part a.

e.   Suppose that revenues rose by $125,000 but expenses rose by $65,000. Would the machine be acceptable under these conditions? Assume a 10-year project life and a salvage value of $12,500.

Chapter 10 Spreadsheet Problem Solutions (C10)
Expansion Project
1. There are a number of instructions with which you should be familiar
to use these computerized models. These instructions appear in a
separate worksheet labeled INSTRUCTIONS. If you have not already
done so, you should read these instructions now. To read these
instructions, click on theworksheet labeled INSTRUCTIONS.
2. The model is set up to deal with a situation where the entire
investment outlay occurs at t=0 and the inflows occur over the
subsequent five to 10 years. Modification of the model would be
required to deal with a shorter or longer time frame.
INPUT DATA:				KEY OUTPUT:
Base price		($260,000)		NPV
Modifications		($15,000)		-6,216
Increase in NWC		($22,500)
Increase in sales revenue		220,000
Operating costs		150,000
Salvage value		8,500
Required rate of return		13%
Tax rate		40%
MACRS class life (years)		5
Useful life (years)		8
MODEL-GENERATED DATA:
Initial investment at t=0:
Base price			($260,000)
Modification			($15,000)
Increase in NWC			($22,500)
Initial investment outlay			($297,500)
Depreciation schedule:					Terminal cash flow:
Depr. basis =	$275,000				Salvage value		8,500
			Ending		Tax on sale of asset		(3,400)
Year	MACRS	Depreciation	Book		Reverse of NWC		22,500
	Rate	Allowance	Value		Terminal CF		27,600
1	0.20	55,000	220,000
2	0.32	88,000	132,000
3	0.19	52,250	79,750
4	0.12	33,000	46,750
5	0.11	30,250	16,500
6	0.06	16,500	0
Annual cash flows:
	0	1	2	3	4	5	6	7	8	9	10
Initial invest.	(297,500)
Sales increase		220,000	220,000	220,000	220,000	220,000	220,000	220,000	220,000	0	0
Operating costs		(150,000)	(150,000)	(150,000)	(150,000)	(150,000)	(150,000)	(150,000)	(150,000)	0	0
Depreciation		(55,000)	(88,000)	(52,250)	(33,000)	(30,250)	(16,500)	0	0	0	0
Earn. b/f taxes		15,000	(18,000)	17,750	37,000	39,750	53,500	70,000	70,000	0	0
Taxes		(6,000)	7,200	(7,100)	(14,800)	(15,900)	(21,400)	(28,000)	(28,000)	0	0
Net income		9,000	(10,800)	10,650	22,200	23,850	32,100	42,000	42,000	0	0
Add back deprec.		55,000	88,000	52,250	33,000	30,250	16,500	0	0	0	0
Supplemental oper. CF		64,000	77,200	62,900	55,200	54,100	48,600	42,000	42,000	0	0
Salvage AT		0	0	0	0	0	0	0	27,600	0	0
Net cash flow	(297,500)	64,000	77,200	62,900	55,200	54,100	48,600	42,000	69,600	0	0
NPV	(6,216)

Answer 1