Question

Harriman Manufacturing Company is evaluating the purchase of a new piece of equipment. The quoted price is $50,000, and it would cost Harriman another $ 10,000 for related capital costs such as transportation and equipment modification for special use. The total investment would fall into MACRS three year class with depreciation rates being applied to the full capitalized costs not excluding salvage at 33%, 45%, 15% and 7% in years 1-4, respectively. Harriman expects that the equipment would be sold in the fourth year, after three years, of use for a price of $20,000. During the three year period spare parts inventory would increase by $3,000 to maintain the equipment, but non-interest bearing accounts payable would increase by $1,000. Although the equipment is not expected to increase the firm's revenue, it is expected to save it $20,000 in before tax labor operating costs. Harriman's marginal tax rate is 40%.

1. Calculate the expected net cash outlay at the beginning of the first year.

2. Estimate the net operating cash flows in years 1, 2 and 3, and assume they occur at the end of each year.

3. What is the dollar value of the non-operating net cash terminal value (i.e., Salvage Value) in the fourth year?

4. If Harriman's weighted average cost of capital is 10%, what are the investment's Net Present Value, Internal Rate of Return and Simple Payback Period? Should the investment be made?

Answer 1

IN Q.3 : NON-OPERATING NET CASH TERMINAL VALUE, WITH SALVAGE VALUE, WORKING CAPITAL RECOVERY SHOULD ALSO COME BUT IN BRACKET, IT IS WRITTEN SALVAGE VALUE SO I HAVE TAKEN SALVAGE VALUE ONLY