In: Accounting
Ferris Industries is planning to replace its old equipment.
The old equipment cost was $350 000 five years ago. The old equipment is fully depreciated.
If the new equipment is purchased, arrangements will be made to sell the old equipment. The old equipment is expected to be sold for only $20 000 on 1 January 2021.
The new equipment will be placed in service on 1 January 2021. The details regarding the proposal are as follows:
Expected increase in sales due to the special production run of the new equipment:
Year 1 to Year 7: |
4000 units each year |
It is assumed that all cash flows occur at the end of each year.
The taxation depreciation on the equipment would be 25% per annum using the straight-line method.
The company is subject to a 40% tax rate.
The company uses a 12% after-tax discount rate.
Required:
a) Calculate the incremental profit (before tax) for each year due to the expected increase in sales.
Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 |
1.After-tax Sale value of old equipment(20000*(1-40%) | 12000 | |||||||
New equipment cost | ||||||||
2.Acquisition cost | -290000 | 46500 | ||||||
3.Installation cost | -20000 | 41517.86 | ||||||
4.Less: PV of investment allowance(290000+20000)*15%/1.12^1 | 41518 | |||||||
5.Net investment in equipment(2+3+4) | -268482 | |||||||
6.After-tax Sale value of new equipment(30000*(1-40%) | 18000 | |||||||
Operating Cash flows: | ||||||||
7.Incremental Sales Units | 4000 | 4000 | 4000 | 4000 | 4000 | 4000 | 4000 | |
8.Incl.Sales $ at $ 300/unit (7*$ 300) | 1200000 | 1200000 | 1200000 | 1200000 | 1200000 | 1200000 | 1200000 | |
9.Incl.Variable cost at $ 250/unit (7*$250) | -1000000 | -1000000 | -1000000 | -1000000 | -1000000 | -1000000 | -1000000 | |
10.Incl. fixed costs | -62000 | -62000 | -62000 | -62000 | -62000 | -62000 | -62000 | |
11.Incl. depn.((268482-30000)*25%) | -59621 | -59621 | -59621 | -59621 | ||||
12.Incl. Profit (before-tax)(sum 8 to 11) | 78380 | 78380 | 78380 | 78380 | 138000 | 138000 | 138000 | |
13.Incl.Tax at 40% (12* 40%) | -31352 | -31352 | -31352 | -31352 | -55200 | -55200 | -55200 | |
14.Incl.profits after-tax(12+13) | 47028 | 47028 | 47028 | 47028 | 82800 | 82800 | 82800 | |
15.Add Back: Depn.(row 11) | 59621 | 59621 | 59621 | 59621 | 0 | 0 | 0 | |
16.Incl.Opg. Cash flows(14+15) | 106648 | 106648 | 106648 | 106648 | 82800 | 82800 | 82800 | |
17.Incl annual.FCFs(1+5+6+16) | -256482 | 106648.2 | 106648.2 | 106648.2 | 106648.2 | 82800 | 82800 | 100800 |
18.PV F at 12%91/1.12^yr.n) | 1 | 0.89286 | 0.79719 | 0.71178 | 0.63552 | 0.56743 | 0.50663 | 0.45235 |
19.PV at 12%(17*18) | -256482 | 95221.61 | 85019.29 | 75910.08 | 67776.86 | 46982.94 | 41949.06 | 45596.8 |
20.NPV at 12% (sum of row 19) | 201974.5 | |||||||
21.IRR(Of FCF row 17) | 35.18% |