Question

In: Accounting

Ferris Industries is planning to replace its old equipment. The old equipment cost was $350 000...

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 acquisition cost $290 000
  • Expected installation costs $20 000
  • Expected investment allowance in Year 1:15%
  • Estimated useful life: 7 years
  • Expected salvage value which can be realised upon its disposal at the end of 7 years: $30 000

Expected increase in sales due to the special production run of the new equipment:

Year 1 to Year 7:

4000 units each year

  • The selling price per unit is expected to remain at $300.
  • The variable cost per unit is expected to be $250.
  • Expected increase in annual fixed costs due to the special production run of the new equipment is $62 000.

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.

Solutions

Expert Solution

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%

Related Solutions

Question 5: (24 marks) Ferris Industries is planning to replace its old equipment. The old equipment...
Question 5: 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 acquisition...
Blossom Industries management is planning to replace some existing machinery in its plant. The cost of...
Blossom Industries management is planning to replace some existing machinery in its plant. The cost of the new equipment and the resulting cash flows are shown in the accompanying table. The firm uses an 18 percent discount rate for projects like this. Should management go ahead with the project? Year Cash Flow 0 -$3,029,000 1 836,610 2 874,500 3 1,100,000 4 1,373,260 5 1,589,400 What is the NPV of this project? (Enter negative amounts using negative sign e.g. -45.25. Do...
Acer is contemplating to replace its old machinery with a new one. The cost of old...
Acer is contemplating to replace its old machinery with a new one. The cost of old machinery is 960,000. The old machinery was bought 6 years ago with a total useful life of 13 years. If sold now, the old machinery can be salvaged at $17,000. The existing machinery has the production capacity of 30,000 units. Acer Inc.'s finished product is called Product X which can be sold at $75, and has per unit variable cost of $42. The annual...
Midwest AIRLINES (MWA) is planning to expand its fleet of jets to replace some old planes...
Midwest AIRLINES (MWA) is planning to expand its fleet of jets to replace some old planes and to expand its routes. It has received a proposal to purchase 112 small jets over the next 4 years. What annual net revenue must each jet produce to break even on its operating cost? The analysis should be done by finding the EUAC for the 10-year planned ownership period. MWA has a MARR of 12%, purchases the jet for $22 million, has operating...
A firm is considering an investment of $480,000 in new equipment to replace old equipment with...
A firm is considering an investment of $480,000 in new equipment to replace old equipment with a book value of $95,000 and a market value of $63,000. If the firm replaces the old equipment with new equipment, it expects to save $120,000 in operating costs the first year. The amount of savings will grow at a rate of 8 percent per year for each of the following five years. Both pieces of equipment belong to asset class 8, which has...
A firm is considering an investment of $480,000 in new equipment to replace old equipment with...
A firm is considering an investment of $480,000 in new equipment to replace old equipment with a book value of $95,000 and a market value of $63,000. If the firm replaces the old equipment with new equipment, it expects to save $120,000 in operating costs the first year. The amount of savings will grow at a rate of 8 percent per year for each of the following five years. Both pieces of equipment belong to asset class 8, which has...
A firm is considering an investment of $480,000 in new equipment to replace old equipment with...
A firm is considering an investment of $480,000 in new equipment to replace old equipment with a book value of $95,000 and a market value of $63,000. If the firm replaces the old equipment with new equipment, it expects to save $120,000 in operating costs the first year. The amount of savings will grow at a rate of 8 percent per year for each of the following five years. Both pieces of equipment belong to asset class 8, which has...
The RW Company is proposing to replace its old welt-making machinery with more modern equipment. The...
The RW Company is proposing to replace its old welt-making machinery with more modern equipment. The new equipment costs $9 million (the existing equipment has zero salvage value). The attraction of the new machinery is that it is expected to cut manufacturing costs from their current level of $8 a welt to $4. However, as the following table shows, there is some uncertainty both about future sales and about the performance of the new machinery: Pessimistic Expected Optimistic Sales, millions...
Monty Industries is considering the purchase of new equipment costing $1,300,000 to replace existing equipment that...
Monty Industries is considering the purchase of new equipment costing $1,300,000 to replace existing equipment that will be sold for $194,000. The new equipment is expected to have a $223,000 salvage value at the end of its 4-year life. During the period of its use, the equipment will allow the company to produce and sell an additional 32,600 units annually at a sales price of $27 per unit. Those units will have a variable cost of $15 per unit. The...
3. A French company is planning to replace the old machine for a new one. The...
3. A French company is planning to replace the old machine for a new one. The new machine will cost Euro 4 million, the old one can not be sold. The new machine will be used for 20 years, then it can be sold for 25% of the purchase price. Each year the company will save Euro 450,000 on the production costs, but the maintenance costs will be higher too: Euro 40,000 per year. The MARR of this company is...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT