Question
In: Finance
• FIN Ltd is considering the purchase of a new photocopier to replace the existing one....
• FIN Ltd is considering the purchase of a new photocopier to replace the existing one. The following information is available.
• The total cost of the NEW is $16,000. The NEW is to be depreciated using the straight-line method with an effective life of 10 years.
• The OLD was purchased 5 years ago for $7500. When it was purchased, the asset had an expected useful life of 15 years and an estimated market value of zero at the end of its life. The machine currently has a market value of $1000.
• As a result of the NEW , sales in each of the next ten years are expected to increase by $2000, and product costs (excluding depreciation) will represent 50% of sales.
• As a result of the NEW, current assets will increase by $5,000 and current liabilities will increase by $2000. The net working capital will be recovered in the terminal year.
• The terminal value of the NEW at the end of Year 10 will be
$3000.
• The company is subject to a 30% tax rate and the cost of capital
is 15%.
i) Compute the NPV. Should FIN accept the project and why?
Solutions
Expert Solution
| Tax rate | 30.00% | ||||||
| Old equipment | |||||||
| Cost | $ 7,500 | ||||||
| Dep-year 1-5 (7500*5/15) | $ 2,500 | 1/15=6.67% | |||||
| WDV | $ 5,000 | ||||||
| Sale price | $ 1,000 | ||||||
| Gain/(Loss), (1000-5000) | $ (4,000) | ||||||
| Tax benefit | $ (1,200) | =-4000*30% | |||||
| Sale price after tax | $ 2,200 | =1000--1200 | |||||
| Cost of new equipment | $ 16,000 | ||||||
| Less sale proceed of old equipment | $ (2,200) | ||||||
| Net investment | $ 13,800 | ||||||
| Depreciation on new equipment | |||||||
| Year | Cost | Dep rate | Depreciation | Depreciation | |||
| 1-10 | $ 16,000 | 10.00% | =16000*10% | $ 1,600 | |||
| Depreciation on old equipment | |||||||
| Year | Cost | Dep rate | Depreciation | Depreciation | |||
| 1-10 | $ 7,500 | 6.67% | =7500*6.67% | $ 500 | |||
| Incremental depreciation | |||||||
| Year | New Depreciation | Old Depreciation | Additional depreciation | ||||
| 1-10 | $ 1,600 | $ 500 | $ 1,100 | ||||
| After tax value of operating profits | |||||||
| Year | Increase in sale | Cost-50% | Cost saving | After tax saving | After tax saving | ||
| 1-10 | $ 2,000 | $ 1,000 | $ 1,000 | =1000*(1-30%) | $ 700 | ||
| Tax shield | |||||||
| Year | Aditional depreciation | Tax shield | Tax shield | ||||
| 1-10 | $ 1,100 | =1100*30% | $ 330 | ||||
| Old equipment | New equipment | ||||||
| WDV | $ - | $ - | |||||
| Sale price | $ - | $ 3,000 | |||||
| Gain/(Loss), (0-0) | $ - | $ 3,000 | |||||
| Tax benefit | $ - | $ 900 | |||||
| Sale price after tax | $ - | $ 2,100 | |||||
| Incremental salvage value | =2100-0 | ||||||
| Incremental salvage value | $ 2,100 | ||||||
| Calculation of working capital | |||||||
| Increase in current assets | $ 5,000 | ||||||
| Increase in current liabilities | $ (2,000) | ||||||
| Increase in working capital | $ 3,000 | ||||||
| Calculation of NPV | 15% | ||||||
| Year | Capital commitment | Working capital | Annual benefit | Dep tax shield | Annual free cashflow | PV factor, 1/(1+r)^time | Total * PV factor |
| 0 | $ (13,800.00) | $ (3,000.00) | $ - | $ - |
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