Question

DataPoint Engineering is considering the purchase of a new piece of equipment for $265,000. It has an eight-year midpoint of its asset depreciation range (ADR). It will require an additional initial investment of $120,000 in nondepreciable working capital. $30,000 of this investment will be recovered after the sixth year and will provide additional cash flow for that year. Income before depreciation and taxes for the next six are shown in the following table. Use Table 12–11, Table 12–12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

Year Amount

1 $ 170,000

2 150,000

3 170,000

4 155,000

5 115,000

6 105,000

The tax rate is 25 percent. The cost of capital must be computed based on the following:

Cost (aftertax) Weights

Debt Kd 7.40 % 30 %

Preferred stock Kp 11.50 10

Common equity (retained earnings) Ke 16.00 60

a. Determine the annual depreciation schedule. (Do not round intermediate calculations. Round your depreciation base and annual depreciation answers to the nearest whole dollar. Round your percentage depreciation answers to 3 decimal places.)

b. Determine the annual cash flow for each year. Be sure to include the recovered working capital in Year 6. (Do not round intermediate calculations and round your answers to 2 decimal places.)

c. Determine the weighted average cost of capital. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

d-1. Determine the net present value. (Use the WACC from part c rounded to 2 decimal places as a percent as the cost of capital (e.g., 12.34%). Do not round any other intermediate calculations. Round your answer to 2 decimal places.)

d-2. Should DataPoint purchase the new equipment? Yes No

Answer 1

a.) Annual Depreciation Schedule

Year	Depreciation rate	Depreciation (265000 * Depreciation rate)
1	0.20	53000
2	0.32	84800
3	0.192	50880
4	0.115	30475
5	0.115	30475
6	0.058	15370

(b.) Determination of Annual Cash Flow for each year :

Annual Cash Flow = [Income before depreciation and taxes * (1 - Tax rate)] + Tax shield on Depreciation

Annual Cash Flow for year 1 = [170000 * (1 - 0.25)] + [53000 * 0.25]

= 127,500 + 13250

= 140750

Annual Cash Flow for year 2 = [150000 * (1 - 0.25)] + [84800 * 0.25]

= 112500 + 21200

= 133700

Annual Cash Flow for year 3 = [170000 * (1 - 0.25)] + [50880 * 0.25]

= 127500 + 12720

= 140,220

Annual Cash Flow for year 4 = [155000 * (1 - 0.25)] + [30475 * 0.25]

= 116250 + 7618.75

= 123868.75

Annual Cash Flow for year 5 = [115000 * (1 - 0.25)] + [30475 * 0.25]

= 86250 + 7618.75

= 93868.75

Annual Cash Flow for year 6 = [105000 * (1 - 0.25)] + [15370 * 0.25] + Recovery of Working Capital

= 78750 + 3842.5 + 30000

= 112,592.5

(c.) Calculation of Weighted Average cost of Capital

WACC = (Cost of After tax Debt * Weight of Debt) + (Cost of Preferred Stock * Weight of Preferred Stock) + ( Cost of Equity * Weight of Equity)

= (7.4% * 0.30) + (11.5% * 0.10) + (16% * 0.60)

= 2.22% + 1.15% + 9.6%

= 12.97%

(d.) Calculation of Net Present Value

Net Present Value = Present value of cash Inflow - Present value of Cash outflow

Present value of Cash Outflow = Initial Investment + Investment in Non Depreciable Working Capital

= 265,000 + 120,000

= 385,000

Year	Cash Flows	PVF @12.97%	Present Value of cash Flows
1	140750	0.885190759	124590.5993
2	133700	0.783562679	104762.3302
3	140220	0.693602442	97256.93447
4	123868.75	0.613970472	76051.75492
5	93868.75	0.543480988	51015.88099
6	112592.5	0.481084348	54166.48946
		Present value of Cash Flows	507843.9893

Net Present Value = 507843.9893 - 385,000

= 122,843.99

d-2) Yes Data Point should purchase the new equipment since it has positive NPV.