Question

“MLK Co” is a manufacturing company which is considering the purchase of a new equipment. The below given summarizes all the information related to the equipment:

-Equipment’s price: $180,000 -Shipping: $20,000

-Payment to find a good place to install the equipment: $30,000

-Useful Life : 4 years

-Depreciation Method: MACRS – 3 year class

-Total Revenues/ year: $100,000 -Operating costs (Excluding Depreciation)/year: $25,000

-Salvage Value: $10,000 -Increase in Current Asset: $23,000 -Increase in Current liabilities (Except N/P): $8,000 -WACC: 9%

-Tax rate: 40% Note: The MACRS rates are 33%, 45%, 15%, and 7% respectively.

1. The net working capital (NWC) equals: *

A. $8,000

B. $15,000

C. $31,000

D. $23,000

E. None of the above

2. The base price of the equipment equals: *

A. $200,000

B. $160,000

C. $180,000

D. $230,000

E. None of the above

3. What is the net cost of the equipment for capital budgeting purposes? *

A. $195,000

B. $223,000

C. $208,000

D. $215,000

E. None of the above

4. The depreciation expense for the 1st year is: *

A. $40,000

B. $66,000

C. $75,900

D. $90,000

E. None of the above

5. The depreciation expense for the 2nd year is: *

A. $103,500

B. $66,000

C. $80,000

D. $90,000

E. None of the above

6. The depreciation expense for the 3rd year is: *

A. $30,000

B. $34,500

C. $66,000

D. $14,000

E. None of the above

7. The depreciation expense for the 4th year is: *

A. $30,000

B. $7,000

C. $14,000

D. $16,100

E. None of the above

8. The after-tax Cash Flow for the 1st year is: *

A. $65,000

B. $71,400

C. $111,000

D. $75,360

E. None of the above

9. The after-tax Cash Flow for the 2nd year is: *

A. $85,000

B. $111,000

C. $81,000

D. $86,400

E. None of the above

10. The after-tax Cash Flow for the 3rd year is: *

A. $57,000

B. $58,800

C. $61,000

D. $87,000

E. None of the above

11. The after-tax Cash Flow for the 4th year is: *

A. $57,000

B. $40,000

C. $50,600

D. $51,440

E. None of the above

12. The Book Value of the equipment at termination is: *

A. $0

B. $10,000

C. $15,000

D. $25,000

E. None of the above

13. The Terminal Value (TV) is: *

A. $25,000

B. $21,000

C. $10,000

D. $70,000

E. None of the above

14. The NPV value of the project is: *

A. $10,460

B. $13,418

C. $41,437

D. $49,258

E. None of the above

Answer 1

1. Net Working capital computation

Increase in current assets	(23,000.00)	-ve since it leads to outflow of cash
Increase in current liabilities	8,000.00	+ve since it leads to inflow of cash
Net working capital	(15,000.00)

Therefore answer is Option B ---> 15000

2. Base price of equipment is $ 180,000 (Option C). Base price is the fundamental cost of the product that does not include any common extra charges

3. Net cost of equipment for capital budgeting

Equipment cost	180,000.00
Shipping	20,000.00
Payment for place to install	30,000.00
Total cost	230,000.00

All costs that are incurred to get the equipment to operational mode can be considered for capital budgeting. However we donot have the answer in the given option. Therefore option E : None of the above needs to be considered

4. Depreciation expense for Year 1

Total equipment cost	230,000.00
Year 1 depreciation rate	33%
Year 1 depreciation	75,900.00

Option C : $75,900 is the correct answer

5. Depreciation expense for Year 2

Total equipment cost	230,000.00
Year 2 depreciation rate	45%
Year 2 depreciation	103,500.00

Option A : $103,500 is the correct answer

6. Depreciation expense for Year 3

Total equipment cost	230,000.00
Year 3 depreciation rate	15%
Year 3 depreciation	34,500.00

Option B : $34,500 is the correct answer

7. Depreciation expense for Year 4

Total equipment cost	230,000.00
Year 4 depreciation rate	7%
Year 4 depreciation	16,100.00

Option D : $16,100 is the correct answer

8,9,10 & 11 : After tax cashflows Year 1,2,3 and 4

Year	1	2	3	4
Total Revenues	100,000.00	100,000.00	100,000.00	100,000.00
Less : Operating costs	25,000.00	25,000.00	25,000.00	25,000.00
Profit before tax and depreciation	75,000.00	75,000.00	75,000.00	75,000.00
Less : Depreciation	75,900.00	103,500.00	34,500.00	16,100.00
Profit before tax	(900.00)	(28,500.00)	40,500.00	58,900.00
Less : Tax @ 40%	(360.00)	(11,400.00)	16,200.00	23,560.00
Profit after tax	(540.00)	(17,100.00)	24,300.00	35,340.00
Add : Depreciation	75,900.00	103,500.00	34,500.00	16,100.00
Cashflow after tax	75,360.00	86,400.00	58,800.00	51,440.00

After tax cashflow for year 1 --> Option D : $75,360

After tax cashflow for year 2 --> Option D : $86,400

After tax cashflow for year 3 --> Option B : $58,800

After tax cashflow for year 4 --> Option D : $51,440

12. Book value of equipment at termination

Year	1	2	3	4
Capital cost / Opening book value	230000	154100	50600	16100
Depreciation rate	33%	45%	15%	7%
Depreciation (Purchase value x depreciation rate)	75900	103500	34500	16100
Closing book value (Opening book value - Closing book value)	154100	50600	16100	0

Therefore closing book value at termination is Option A ---> 0

13 . Terminal value - Option C ---> $ 10000

14. NPV

After tax salvage value computation
Salvage value	10,000.00
Less : Book value at termination	-
Profit on salvage value	10,000.00
Less : Tax @ 40%	4,000.00
Profit after tax	6,000.00
Add : Book value on termination	-
Terminal after tax cashflow	6,000.00
Year	0	1	2	3	4
Initial cashflow
Equipment cost	(180,000.00)
Shipping	(20,000.00)
Payment for place to install	(30,000.00)
Total Equipment cost	(230,000.00)
Net working capital incrrease	(15,000.00)
Total Initial cashflows	(245,000.00)
Intermediate cashflows
Total Revenues		100,000.00	100,000.00	100,000.00	100,000.00
Less : Operating costs		25,000.00	25,000.00	25,000.00	25,000.00
Profit before tax and depreciation		75,000.00	75,000.00	75,000.00	75,000.00
Less : Depreciation		75,900.00	103,500.00	34,500.00	16,100.00
Profit before tax		(900.00)	(28,500.00)	40,500.00	58,900.00
Less : Tax @ 40%		(360.00)	(11,400.00)	16,200.00	23,560.00
Profit after tax		(540.00)	(17,100.00)	24,300.00	35,340.00
Add : Depreciation		75,900.00	103,500.00	34,500.00	16,100.00
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