Question
In: Accounting
An assembly operation at a software company currently requires $96,000 per year in labor costs. A...
An assembly operation at a software company currently requires $96,000 per year in labor costs. A robot can be purchased and installed to automate this operation, and the robot will cost $192,000 with no MV at the end of its 10-year life. The robot, if acquired, will be depreciated using SL depreciation to a terminal BV of zero after 10 years. Maintenance and operation expenses of the robot are estimated to be $70,000per year. The company has an effective income tax rate of 24%. Invested capital must earn at least 6% after income taxes are taken into account.
a. Use the IRR method to determine if the robot is a justifiable investment.
b. If MACRS (seven-year recovery period) had been used in Part (a), would the after-tax IRR be lower or higher than your answer to Part (a)?
Solutions
Expert Solution
| a) | |||||||||||
| Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 |
| Initial Investment | $ (192,000) | ||||||||||
| Annual Net Savings =(96000 -70000) | $ 26,000 | $ 26,000 | $ 26,000 | $ 26,000 | $ 26,000 | $ 26,000 | $ 26,000 | $ 26,000 | $ 26,000 | $ 26,000 | |
| Less: Depreciation | $ 19,200 | $ 19,200 | $ 19,200 | $ 19,200 | $ 19,200 | $ 19,200 | $ 19,200 | $ 19,200 | $ 19,200 | $ 19,200 | |
| Net Operating Income | $ 6,800 | $ 6,800 | $ 6,800 | $ 6,800 | $ 6,800 | $ 6,800 | $ 6,800 | $ 6,800 | $ 6,800 | $ 6,800 | |
| Less: Tax @ 24% | $ 1,632 | $ 1,632 | $ 1,632 | $ 1,632 | $ 1,632 | $ 1,632 | $ 1,632 | $ 1,632 | $ 1,632 | $ 1,632 | |
| Net Income | $ 5,168 | $ 5,168 | $ 5,168 | $ 5,168 | $ 5,168 | $ 5,168 | $ 5,168 | $ 5,168 | $ 5,168 | $ 5,168 | |
| Add: Depreciation | $ 19,200 | $ 19,200 | $ 19,200 | $ 19,200 | $ 19,200 | $ 19,200 | $ 19,200 | $ 19,200 | $ 19,200 | $ 19,200 | |
| Net operating Cash flow | $ (192,000) | $ 24,368 | $ 24,368 | $ 24,368 | $ 24,368 | $ 24,368 | $ 24,368 | $ 24,368 | $ 24,368 | $ 24,368 | $ 24,368 |
| IRR | 4.59% | ||||||||||
| b) | |||||||||||
| Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 |
| Initial Investment | $ (192,000.00) | ||||||||||
| Annual Net Savings =(96000 -70000) | $ 26,000.00 | $ 26,000.00 | $ 26,000.00 | $ 26,000.00 | $ 26,000.00 | $ 26,000.00 | $ 26,000.00 | $ 26,000.00 | $ 26,000.00 | $ 26,000.00 | |
| Less: MACRS (seven-year recovery period) | $ 27,436.80 | $ 47,020.80 | $ 33,580.80 | $ 23,980.80 | $ 17,145.60 | $ 17,126.40 | $ 17,145.60 | $ 8,563.20 | |||
| Net Operating Income | $ (1,436.80) | $ (21,020.80) | $ (7,580.80) | $ 2,019.20 | $ 8,854.40 | $ 8,873.60 | $ 8,854.40 | $ 17,436.80 | $ 26,000.00 | $ 26,000.00 | |
| Less: Tax @ 24% | $ (344.83) | $ (5,044.99) | $ (1,819.39) | $ 484.61 | $ 2,125.06 | $ 2,129.66 | $ 2,125.06 | $ 4,184.83 | $ 6,240.00 | $ 6,240.00 | |
| Net Income | $ (1,091.97) | $ (15,975.81) | $ (5,761.41) | $ 1,534.59 | $ 6,729.34 | $ 6,743.94 | $ 6,729.34 | $ 13,251.97 | $ 19,760.00 | $ 19,760.00 | |
| Add: Depreciation | $ 27,436.80 | $ 47,020.80 | $ 33,580.80 | $ 23,980.80 | $ 17,145.60 | $ 17,126.40 | $ 17,145.60 | $ 8,563.20 | $ - | $ - | |
| Net operating Cash flow | $ (192,000.00) | $ 26,344.83 | $ 31,044.99 | $ 27,819.39 | $ 25,515.39 | $ 23,874.94 | $ 23,870.34 | $ 23,874.94 | $ 21,815.17 | $ 19,760.00 | $ 19,760.00 |
| IRR | 4.93% | ||||||||||
| This is less than the after-tax MARR, so the robot should not be purchased. |
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