Question

Question Help P11-29 (similar to) Integrative-Complete investment decision Wells Printing is considering the purchase of a new printing press. The total installed cost of the press is $2.27 million. This outlay would be partially offset by the sale of an existing press. The old press has zero book value, cost $0.97 million 10 years ago, and can be sold currently for $1.23 million before taxes. As a result of acquisition of the new press, sales in each of the next 5 years are expected to be $1.69 million higher than with the existing press, but product costs (excluding depreciation) will represent 53% of sales. The new press will not affect the firm's net working capital requirements. The new press will be depreciated under MACRS I using a 5-year recovery period. The firm is subject to a 40% tax rate. Wells Printing's cost of capital is 11.2%. (Note: Assume that the old and the new presses will each have a terminal value of $0 at the end of year 6.) a. Determine the initial investment required by the new press b. Determine the operating cash flows attributable to the new press. (Note: Be sure to consider the depreciation in year 6.) c. Determine the payback period. Operating Cash Inflows

Answer 1

(All figures in $ Millions except the final answer NPV in $
a.Initial investment reqd. by the new press:
Installed cost of the new m/c	2.27	mlns.
Less: After-tax salvage of the old m/c(1.23*(1-40%))	0.738	mlns.
Net initial outlay	1.532	mlns.

Year	0	1	2	3	4	5	6
1.Initial investment(as above)	-1.532
b.Operating cash flows:
2.Incremental revenues		1.69	1.69	1.69	1.69	1.69
3.Incl.product costs(53%*revenues)		-0.8957	-0.8957	-0.8957	-0.8957	-0.8957
4.MACRS depn.		-0.3064	-0.49024	-0.29108	-0.18384	-0.18384	-0.0766
5.Incl.EBT(2+3+4)		0.4879	0.30406	0.50322	0.61046	0.61046	-0.0766
6.Incl.Tax at 40%(5*40%)		-0.19516	-0.12162	-0.20129	-0.24418	-0.24418	0.03064
7.Incl.EAT(5+6)		0.29274	0.182436	0.301932	0.366276	0.366276	-0.04596
8.Add back: Depn.(Row 4)		0.3064	0.49024	0.29108	0.18384	0.18384	0.0766
9.Incl.Opg.Cash flow(7+8)		0.59914	0.672676	0.593012	0.550116	0.550116	0.03064
10.Total annual c/fs(1+9)	-1.532	0.59914	0.672676	0.593012	0.550116	0.550116	0.03064
11.Cumulative c/fs	-1.532	-0.93286	-0.26018	0.332828	0.882944	1.43306	1.4637
12.Payback period=
2+(0.26018/0.93286)=
2.28	(ANSWER:c)
Years
13.IRR(of Row 10)	28%
NPV:
14.PV F at 11.2%(1/1.112^Yr.n)	1	0.89928	0.80871	0.72725	0.65400	0.58813	0.52890
15.PV at 11.2%(10*14)	-1.532	0.538795	0.543997	0.43127	0.359778	0.323542	0.016205
16.NPV(Sum of Row 15)	0.681587
ie.	$681,587