Question

Universal Electronics is considering the purchase of manufacturing equipment with a 10-year midpoint in its asset depreciation range (ADR). Carefully refer to Table 12–11 to determine in what depreciation category the asset falls. (Hint: It is not 10 years.) The asset will cost $130,000, and it will produce earnings before depreciation and taxes of $36,000 per year for three years, and then $18,000 a year for seven more years. The firm has a tax rate of 36 percent. Assume the cost of capital is 10 percent. In doing your analysis, if you have years in which there is no depreciation, merely enter a zero for depreciation. Use Table 12–12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. a. Calculate the net present value. (Do not round intermediate calculations and round your answer to 2 decimal places.) b. Based on the net present value, should Universal Electronics purchase the asset? Yes No

Answer 1

	As per Table 12-11,Properties with 10 year midpoint in ADR will fall into 7 Year MACRS
	Most of the manufacturing equipment fall in this category
		Present Value (PV) of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=Discount Rate=Cost of Capital=10%=0.1
		N=Year of Cash Flow
	N	Year	0	1	2	3	4	5	6	7	8	9	10
	A	Initial Cost	($130,000)
	EBDT	Earning Before Depreciation & Taxes		$36,000	$36,000	$36,000	$18,000	$18,000	$18,000	$18,000	$18,000	$18,000	$18,000
	B	MACRS 7 Year Depreciation Rate		14.29%	24.49%	17.49%	12.49%	8.93%	8.92%	8.93%	4.46%	0.00%	0.00%
	C=130000*B	Annual Depreciation		$18,577	$31,837	$22,737	$16,237	$11,609	$11,596	$11,609	$5,798	$0	$0
	EBT=EBDT-C	Earning Before Taxes		$17,423	$4,163	$13,263	$1,763	$6,391	$6,404	$6,391	$12,202	$18,000	$18,000
	T=EBT*36%	Taxes		$6,272	$1,499	$4,775	$635	$2,301	$2,305	$2,301	$4,393	$6,480	$6,480
	D=EBT-T	Operating Income		$11,151	$2,664	$8,488	$1,128	$4,090	$4,099	$4,090	$7,809	$11,520	$11,520
	C	Add: Depreciation (Non Cash expense)		$18,577	$31,837	$22,737	$16,237	$11,609	$11,596	$11,609	$5,798	$0	$0
	CF=D+C+A	Cash flow	($130,000)	$29,728	$34,501	$31,225	$17,365	$15,699	$15,695	$15,699	$13,607	$11,520	$11,520	SUM
	PV=CF/(1.1^N)		($130,000)	$27,025.20	$28,513.49	$23,460.05	$11,860.75	$9,747.99	$8,859.17	$8,056.19	$6,347.90	$4,885.60	$4,441.46	$3,197.79
	NPV=Sum of PV	Net Present Value	$3,197.79
		YES,
		Universal Electronics should purchase the asset
		Because Net Present Value is positive