Question
In: Finance
(Please show work and equations used) Central Food Inc., is considering replacing its current production line...
(Please show work and equations used)
Central Food Inc., is considering replacing its current production line to improve efficiency. The new production line will cost $650,000 plus $50,000 for shipping and installation. The current production line has a book value of $0 and an estimated market value of $119,666.67. CF uses straight-line depreciation method and has a marginal tax rate of 25% for net income and capital gain.
CF’s current annual sales is $433,000 and by estimation, the new production line can increase CF’s annual sales by about 28%. NWC will rise by $35,000. And due to higher maintenance cost, the operating costs will rise by $15,000 each year. In 11 years the production line currently under consideration can be sold for $110,000.
CF’s require rate of return is 11%.
For this replacement project:
1) Find initial investment and all the future incremental cash flows. [25 pts]
** ignore the depreciation on the old production line when finding the “increase in depreciation” for this replacement project.
2) Put all cash flows in #1 on a timeline. [5 pts]
3) Find the discounted payback period. If the threshold is 4.5 years, should CF accept his project? [20 pts]
4) Find the net present value. Should CF accept this project? [20 pts]
5) Find the profitability index. Should CF accept this project? [10 pts]
6) Find the modified internal rate of return. Should CF accept this project? [20 pts]
Solutions
Expert Solution
| Central Food Inc. | |
| New Production line cost | 650,000.00 |
| Add , Shipping & installation | 50,000.00 |
| Total Capital Invenstment in production line | 700,000.00 |
| Salvage value after 11 years | 110,000.00 |
| Depreciable Value | 590,000.00 |
| Sl depreciation per year over 11 years= | 53,636.36 |
| Tax rate = | 25% |
| Annual depreciation Tax savings =53636.36*25%= | 13,409.09 |
| Old Machine book value | - |
| Old machine current sales price | 119,666.67 |
| Capital Gain of sale of old machine | 119,666.67 |
| Tax on Capital gain @25% tax rate= | $ 29,916.67 |
| Increase in NWC | 35,000 |
| Incremental Annual Sales =$433000*28%= | 121,240 |
| Incremental Annual Operating Cost | 15,000 |
| Incremental Income (w/o depreciation) | 106,240.00 |
| Tax @ 25% | 26,560.00 |
| Incremental After Tax Annual Income | 79,680.00 |
| Required Rate of Return | 11% |
| FCF And NPV Calculation : | |||||||||||||
| Details | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 | Year 8 | Year 9 | Year 10 | Year 11 | |
| Initial Investment | |||||||||||||
| Investment in Product Line | (700,000.00) | ||||||||||||
| Sale proceeds from old machine | 119,666.67 | ||||||||||||
| Less Tax on Capital Gain of Salvage | (29,916.67) | ||||||||||||
| Investment in NWC | (35,000.00) | ||||||||||||
| a | Total Initial Investment | (645,250.00) | |||||||||||
| Cash flow from Operations | |||||||||||||
| After Tax Inceremental Income | 79,680.00 | 79,680.00 | 79,680.00 | 79,680.00 | 79,680.00 | 79,680.00 | 79,680.00 | 79,680.00 | 79,680.00 | 79,680.00 | 79,680.00 | ||
| Add : Depreciation Tax shield | 13,409.09 | 13,409.09 | 13,409.09 | 13,409.09 | 13,409.09 | 13,409.09 | 13,409.09 | 13,409.09 | 13,409.09 | 13,409.09 | 13,409.09 | ||
| b | Total Cash flow from Operations | 93,089.09 | 93,089.09 | 93,089.09 | 93,089.09 | 93,089.09 | 93,089.09 | 93,089.09 | 93,089.09 | 93,089.09 | 93,089.09 | 93,089.09 | |
| Terminal Cash flow | |||||||||||||
| Salvage value | 110,000.00 | ||||||||||||
| Return of NWC | 35,000.00 | ||||||||||||
| c | Total Terminal Cash flow | 145,000.00 | |||||||||||
| d | Free Cash flow from Project =a+b+c ( ans 1+2) | (645,250.00) | 93,089.09 | 93,089.09 | 93,089.09 | 93,089.09 | 93,089.09 | 93,089.09 | 93,089.09 | 93,089.09 | 93,089.09 | 93,089.09 | 238,089.09 |
| e | PV factor @11%=1/1.11^n | 1.00 | 0.9009 | 0.8116 | 0.7312 | 0.6587 | 0.5935 | 0.5346 | 0.4817 |
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production line to improve efficiency. The new production line will
cost $650,000 plus $50,000 for shipping and installation. The
current production line has a book value of $0 and an estimated
market value of $119,666.67. CF uses straight-line depreciation
method and has a marginal tax rate of 25% for net income and
capital gain.
CF’s current annual sales is $433,000 and by estimation, the new
production line can increase CF’s annual sales...
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cost $650,000 plus $50,000 for shipping and installation. The
current production line has a book value of $0 and an estimated
market value of $119,666.67. CF uses straight-line depreciation
method and has a marginal tax rate of 25% for net income and
capital gain.
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