Question

In: Accounting

The Jones Company has just completed the third year of a​ five-year MACRS recovery period for...

The Jones Company has just completed the third year of a​ five-year MACRS recovery period for a piece of equipment it originally purchased for

$ 296 comma 000$296,000.

a. What is the book value of the​ equipment?

b. If Jones sells the equipment today for

$ 182 comma 000$182,000

and its tax rate is

35 %35%​,

what is the​ after-tax cash flow from selling​ it?

c. Just before it is about to sell the​ equipment, Jones receives a new order. It can take the new order if it keeps the old equipment. Is there a cost to taking the order and if​ so, what is​ it? Explain.​ (Assume the new order will consume the remainder of the​ machine's useful​ life.)

Note​:

Assume that the equipment is put into use in year 1.

2.

ou are considering the following two projects and can take only one. Your cost of capital is

11.0 %11.0%.

The cash flows for the two projects are as follows​ ($ million):

Project

Year 0

Year 1

Year 2

Year 3

Year 4

A

negative $ 100−$100

$ 25$25

$ 30$30

$ 40$40

$ 50$50

B

negative $ 100−$100

$ 50$50

$ 40$40

$ 30$30

$ 20$20

a. What is the IRR of each​ project?

b. What is the NPV of each project at your cost of​ capital?

c. At what cost of capital are you indifferent between the two​ projects?

d. What should you​ do?

Solutions

Expert Solution

(1)

(a) What is the book value of the​ equipment?

Book Value of Equipment = (Purchase Price) * (1 - sum of MACR rates from Beginning to Current Date)               

                                               = (296,000) * (1 – 0.20 – 0.32 – 0.192)

                                               = 296,000 * 0.288

                                               = $85,248

(b) What is the​ after-tax cash flow from selling​ it ?

Sale Value = $182,000

Tax Rate = 35%

After-Tax Cash Flow = Selling Price * (1-Tax Rate) + (Book Value * Tax Rate)

                                     = 182,000 (1 -0.35) + (85,248 * 0.35)

                                     = (182,000 * 0.65) + (29,837)

                                     = $148,137

(c ) Cost of taking new order

The cost to taking the new order is the loss of after-tax cash flow of $148,137 which the Jones company would have received on selling the equipment i.e. the opportunity cost.

(2)

Working

(d) Project B is recommended as it has higher IRR and NPV as compared to Project A

ekkarill92 answered 1 year ago
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