Question
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“MLK Co” is a manufacturing company which is considering the purchase of a new equipment. The...
“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
Solutions
Expert Solution
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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