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ABC Ltd is negotiating for the purchase of a new piece of equipment for their current...
ABC Ltd is negotiating for the purchase of a new piece of equipment for their current operations. The new equipment would replace existing equipment that was purchased 5 years ago for $50,000 and is being depreciated to zero on a straight-line basis over its effective life of 10 years. The old equipment has a current scrap value of $16,000 and it would be $1,000 in 5 years’ time.
The supplier has quoted a selling price of $60,000 for the new equipment which has an expected economic life of 5 years. The tax authorities allow a 20% investment allowance on the new equipment and its full cost to be depreciated to zero on a straight-line basis over 4 years. ABC expects to be able to sell the equipment for $3,000 at the end of 5 years. As the new equipment is fully automated, it would reduce the operating costs by $18,000 per year, but it requires ABC to hold additional inventory to a value of $4,000.
ABC has profitable ongoing operations and its before-tax cost of capital is 20%. The revenues will not be affected by the purchase of the new equipment. All cash flows are assumed to occur at year-end and the corporate tax rate is 30%.
Prepare the cash flow table (which incorporates taxes and includes initial investment, operating and terminal cash flows) for the project using the information given above. As the financial analyst of the company, you are asked to determine whether ABC Ltd should buy the new equipment based on the net present value (NPV) and internal rate of return (IRR) methods.
Solutions
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