Question

Two years ago, a steel company installed a blast furnace for a total of $ 19,200. Due to a technological change, another type of more efficient furnace can be purchased for $ 208,000 with a savings of $ 38,000 per year of fuel compared to the current frontier. Maintenance costs are estimated at $ 8,000 and $ 4800 per year for the new furnace and the current furnace, respectively. For accounting purposes, taxes and depreciation charges are calculated by the straight-line method, with residual values ​​null and life of 10 and 12 years for new and current furnaces, respectively. Other costs (insurance, etc.) will remain unchanged regardless of the type of furnace used. Both equipment, once installed, only has value as scrap, with the cost of removal of value approximately equal. The interest rate, after taxes deducted, is 12% per year. Consider for the analysis a tax rate of 50% on taxable income and that once you have opted for an equipment, it will be held for 10 years.

Answer 1

	Incremental cash flow /(cost)
savings in Fuel	38000
less:Incremental maintenance cost	(3200)      [8000-4800]
Incremental depreciation	(19200)    [20800-1600]
Incremental income before tax	15600
less:tax [15600*.50]	(7800)
Income after tax	7800
add:depreciation (non cash)	19200
Net incremental cash flow	27000

Present value of annual incremental cash flow =PVA12%,10* Net incremental cash flow

                          = 5.65022* 27000

                        = $ 152555.94

NPV = present value -initial cost

      = 152,555.94 - 208000

      = - 55,444.06

**since NPV of buying new Furnace is negative ,it should not be purchased.

WORKING:

**Depreciation on old furnace = 19200/12=1600 per year

Depreciation on new Furnace = 208000/10= 20800

**Find present value annuity factor from present value annuity table (ordinary) at 12%,10 or using financial calculator.