Question

Problem 12-30 Working capital requirements in capital budgeting [LO12-4] The Spartan Technology Company has a proposed contract with the Digital Systems Company of Michigan. The initial investment in land and equipment will be $335,000. Of this amount, $310,000 is subject to five-year MACRS depreciation. The balance is in nondepreciable property. The contract covers six years; at the end of six years, the nondepreciable assets will be sold for $25,000. The depreciated assets will have zero resale value. Use Table 12-12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. The contract will require an additional investment of $65,000 in working capital at the beginning of the first year and, of this amount, $45,000 will be returned to the Spartan Technology Company after six years. The investment will produce $104,000 in income before depreciation and taxes for each of the six years. The corporation is in a 30 percent tax bracket and has a 14 percent cost of capital. a. Calculate the net present value.(Do not round intermediate calculations and round your answer to 2 decimal places.) b. Should the investment be undertaken? No Yes References WorksheetProblem 12-30 Wo

Answer 1

All financials below are in $.

The initial investment in land and equipment will be $335,000. Of this amount, $310,000 is subject to five-year MACRS depreciation. The balance is in non-depreciable property.

Value of non-depreciable property = 335,000 - 310,000 = 25,000

Sale value of non-depreciable property at the end of 6 years = 25,000

Since sale value = book value, there is no gain or loss on sale of non-depreciable property. Hence there will no tax impact.

Hence, post tax Sale value of non-depreciable property at the end of 6 years = 25,000

As a first step, let's roll out the depreciation schedule. Please see the second column, that will help you understand how each row has been calculated.

Year	N	0	1	2	3	4	5	6
Depreciable Investment	P	310,000
5 Years MACRS depreciation	Q		20.00%	32.00%	19.20%	11.52%	11.52%	5.76%
Annual Depreciation	R = P x Q		62,000	99,200	59,520	35,712	35,712	17,856

In the table below, I have put together the relevant cash flows, year wise. Please see the second column, that will help you understand how each row has been calculated. Figures in parenthesis are negative values.

Year	N	0	1	2	3	4	5	6
Initial investment in land and equipment	A	(335,000)
Initial investment in working capital	B	(65,000)
Post tax Sale value of non-depreciable investment	C							25000
Return of working capital	D							45000
EBITDA	E		104000	104000	104000	104000	104000	104000
[-] Depreciation	R (from table above)		(62,000)	(99,200)	(59,520)	(35,712)	(35,712)	(17,856)
EBIT	F = E + R		42,000	4,800	44,480	68,288	68,288	86,144
[-] Taxes	G = -30% x F		(12,600)	(1,440)	(13,344)	(20,486)	(20,486)	(25,843)
NOPAT	H = F + G		29,400	3,360	31,136	47,802	47,802	60,301
[+} Depreciation	R (from table above)		62,000	99,200	59,520	35,712	35,712	17,856
Annual post tax operating cash flows	I = H + R		91,400	102,560	90,656	83,514	83,514	78,157
Net Cash flows	J = A + B + C + D + I	(400,000)	91,400	102,560	90,656	83,514	83,514	148,157

Discount rate, R = 14%, If C_i represents the cash flow in the year i then,

Part (a)

=  - $19,398.41

Hence, NPV = - $ 19,398.41

b. Should the investment be undertaken?

Since the NPV is negative, the investment should not be undertaken. Hence, please choose your answer as "No".