Question

ACME Manufacturing in investing in new technology to improve the productivity of its operations which is estimated to produce yearly savings of $45,000. To achieve this, ACME will need to undertake upfront capital investment of $100,000 and $25,000 in net working capital. The equipment will be depreciated on a straight-line basis over 3 years. The working capital is expected to be recovered at the end of year three. The new equipment is estimated to have a salvage value of $50,000 at the end of the third year, when its sold. ACME’s tax rate is 21% and its required rate of return is 9.0%. What is ACME’s estimated EAT (earnings after-tax, excluding gains or losses on asset sales) for year three? A. $11,667. B. $45,000. C. $9,217 D. $42,550. E. Insufficient information

Based on the information in question 26, what is the FCF in year three? A. $107,050. B. $42,550. C. $9,217. D. $82,050. E. Insufficient information

Based on the information question 26, and further assuming ACME requires a payback period of 2.0 years or better, will ACME make this investment? A. Yes. B. No. C. Insufficient information

Answer 1

		0	1	2	3
	Yearly savings		$        45,000	$         45,000	$         45,000
	Depreciation [100000/3]		$        33,333	$         33,333	$         33,333
	Incremental NOI		$        11,667	$         11,667	$         11,667
	Tax at 21%		$           2,450	$           2,450	$           2,450
	EAT		$           9,217	$           9,217	$           9,217
	Add: Depreciation		$        33,333	$         33,333	$         33,333
	Incremental OCF		$        42,550	$         42,550	$         42,550
	Capital expenditure	$        1,00,000
	Change in NWC	$            25,000			$       -25,000
	After tax salvage value [50000*(1-21%)]				$         39,500
	FCF	$      -1,25,000	$        42,550	$         42,550	$     1,07,050
	What is ACME’s estimated EAT (earnings after-tax, excluding gains or losses on asset sales) for year three?
	Answer: [D] $42,550
	Based on the information in question 26, what is the FCF in year three?
	Answer: [A] $107,050
	CALCULATION OF PAYBACK PERIOD:
	Cumulative FCF	$      -1,25,000	$       -82,450	$       -39,900	$         67,150
	Payback period = 2+39900/107050 =	2.37	Years
	As the payback is more than 2.00 years, ACME will not make the investment.
	Answer: [B] No.