Question

Suda Marine Engines, Inc. must develop the relevant cash flows for a replacement capital investment proposal. The proposed asset costs $50,000 and has installation costs of $5,000 and will be put into operation for the next three years. The asset will be depreciated using a three-year recovery schedule (with MARCS depreciation rates of 45%, 33%, 15%, 7% for years 1 to 4). The existing equipment, which originally cost $25,000 is fully depreciated and has no salvage value today. The new equipment is expected to result in incremental before tax revenue of $15,000 per year but has no effect on cost. As a result of this replacement, net working capital rises by $5,000 today but will be recovered at the end of the 3rd year. The new machine is expected to be sold for $15,000 before taxes at the end of 3rd year. The firm has a 40 percent tax rate and its cost of capital is 10%.

a) What is the new asset's initial cash outlay?
b) What are the new asset's depreciations?
c) What are the new  asset's operating cash flows for the years 1, 2, & 3?
d) What is the new  asset's terminal cash flow?
e) What is the NPV of this asset? Should Suda buy the new asset?

Answer 1

a) What is the new asset's initial cash outlay?

$55000
b) What are the new asset's depreciations?

Year 1 = 24750

Year 2 = 18150

Year 1 = 8250

c) What are the new  asset's operating cash flows for the years 1, 2, & 3?

OCF Year 1 = $18900

OCF Year 2 = $16260

OCF Year 3 = $12300

d) What is the new  asset's terminal cash flow?

15000 - 4460 = $10540

e) What is the NPV of this asset? Should Suda buy the new asset?

NPV = -$8463.56

as NPV is negative it is not recommended to buy the asset

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