Question

Capital Budgeting Analysis - Use the information below to prepare for cash flow analysis in a table for both scenarios
Please create your table from Colume L and keep this statement here as it is.
You must show the analysis and results from both scenarios based on your cash flow analysis table and make your decision
Decision without data support will be given 0 points.

Micro-Technologies is a Bio Tech research firm that is conducting research on a cure

for Aids. Their sole current source of revenues is from the sale of research data that they

have collected about the virus (Ultimately, they are hoping to find an Aids vaccine that

will be worth billions, the research data they are selling is only being to finance

continuing research). The firm is considering the purchase of an electron microscope that

will cost $2,000,000, and have a useful life of five years. At the end of the five years, the

microscope will have an estimated salvage value of $500,000. If the firm purchases the

scope, there will also be an associated maintenance cost of $50,000 per year. One

possible alternative is to lease the equipment for the same period of time for $375,000 per

year, with all maintenance assumed by the lessor. For simplicity, treat lease payments as

if due at the end of the year.

If the before project EBIT is $500,000 per year, the borrowing rate (before-tax is

12%), and the tax rate is 30%, what should the firm do?

Answer 1

The cash-flows under both the scenario are give below:-

Purchase Price	2000000	Assuming Purchased using Borrowed Money
Useful Life	5 years
Salvage Value After 5 Years	500000
Depreciation per year	300000	Assuming Straight Line Method
Purchasing the Equipment
	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Purchase Cost	-2000000
EBIT		500000	500000	500000	500000	500000
Maintenance Cost		50000	50000	50000	50000	50000
Interest Cost		240000	240000	240000	240000	240000
PBT		210000	210000	210000	210000	210000
PAT		147000	147000	147000	147000	147000
Add: Tax Shield On Depreciation		90000	90000	90000	90000	90000
Add: Salvage Value						500000
Net Cash Flows	-2000000	237000	237000	237000	237000	737000
IRR	-4.59%
Taking the Equipment on Lease
	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
EBIT		500000	500000	500000	500000	500000
Lease Cost		375000	375000	375000	375000	375000
Profit Before Tax		125000	125000	125000	125000	125000
Profit After Tax		87500	87500	87500	87500	87500

The calculation of the same is below