Question

In: Finance

Anchor Ltd paid $15,000 last quarter for a feasibility study regarding the demand for motorboat replacement...

Anchor Ltd paid $15,000 last quarter for a feasibility study regarding the demand for motorboat replacement parts which would require the purchase of a new metal-shaping machine. Today, they wish to conduct an analysis of the proposed project.
The machine costs $250,000 and will operate for five years and tax rules allow the machine to be depreciated to zero over a five-year life. The machine is expected to produce sales of $135,000 annually for the five years. Anchor has already agreed to sell the machine in five years’ time to an unrelated firm for $80,000.
The project will result in a $35,000 increase in accounts receivable and require an increase in inventory levels by $20,000 to $95,000. Anchor has negotiated with its bank to borrow $180,000 to help pay for the project. Loan repayments are $48,000 each year for five years.
If Anchor buys the machine they will be able to use some equipment that they currently own. This is part of the driving force in the decision making as it enables the company to save money in not buying additional new equipment. This equipment was bought for $120,000 six years ago and could be sold today for $63,000. This equipment has been written off for tax purposes and would be worthless in five years’ time.
If the company tax rate is 30% and the appropriate discount rate is 19.5%, should Anchor buy the new machine?

Solutions

Expert Solution

INITIAL INVESTMENT:
Cost of the machine 250000
Increase in NWC = 35000+20000 = 55000
After tax value of old equipments that can be used = 63000*(1-30%) = 44100
Incremental initial investment 349100
ANNUAL OPERATING CASH FLOWS:
Increase in sales 135000
Depreciation (250000/5) 50000
Incremental EBIT 85000
Tax at 30% 25500
Incremental NOPAT 59500
Add: Depreciation 50000
Incremental OCF 109500
TERMINAL NON OPERATING CASH FLOWS:
Recovery of NWC 55000
After tax salvage value = 80000*70% = 56000
Terminal non operating cash flows 111000
NPV:
PV of annual OCF = 109500*(1.195^5-1)/(0.195*1.195^5) = 331108
PV of terminal cash inflow = 111000/1.195^5 = 45549
PV of cash inflows 376657
Less: Initial investment 349100
NPV 27557
AS THE NPV OF THE BUYING OF THE MACHINE IS POSITIVE,
THE MACHINE CAN BE BOUGHT.

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