Question

A construction company is considering to acquire a new equipment.Table 1 is the information of two alternatives for this new equipment. Complete the following questions according to the PW analysis The after tax market minimum attractive acquire

(1) which alternative should the company acquire?

(2)if the inflation rate is 2% per year and the base year is year 0,whic company should you choose?

Table 1 Capital investment А 9000 в 30000 9000 3000 Annual benefit (increases per year as the inflation rate if inflation is considered) Depreciation method Straight Line 200% Declining Balance 3 years 10 Depreciation life Salvage Value Useful life Market value (increases per year as the inflation rate if inflation is considered) 3 years 2000 5 years 2000 5 years 2000

PW is Present Value

use Present Value method to analyze

Answer 1

		Present Value(PV) of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=discount rate =MARR=`12%=0.12
		N=Year   of Cash Flow
		TAX RATE (Assumed 30%)
	4.1	WITHOUT CONSIDERING INFLATION
		Annual Depreciation =(9000-2000)/3	2333
		Annual Depreciation Tax shield=2333*30%	700
		CASH FLOW ANALYSIS OF ALTERNATIVE A
	N	Year	0	1	2	3	4	5
	a	Capital Investment	(9,000)
	b	Annual Benefits(After Tax)=3000*(1-0.3)		2,100	2,100	2,100	2,100	2,100
	c	Annual Depreciation Tax shield		700	700	700
	d	After tax salvage value						2,000
	CF=a+b+c+d	Net Cash Flow	(9,000)	2,800	2,800	2,800	2,100	4,100	SUM
	PV=CF/(1.12^N)	Present Value of Net Cash Flow	(9,000)	2,500	2,232	1,993	1,335	2,326	1,386
	NPV=Sum of PV	Present Worth	1,386
	4.1	WITHOUT CONSIDERING INFLATION
		ALTERNATIVE B
		Year	1	2	3
	A	Beginning Book Value	30000	10,000	3,333
	B	Depreciation rate=2*(1/3)	66.67%	66.67%	66.67%
	C=A*B	Annual Depreciation	20000	6667	1333
	D=A-B	Ending Book Value	10000	3333	2000
	E=C*30%	Annual Depreciation Tax shield	6000	2000	400
		CASH FLOW ANALYSIS OF ALTERNATIVE B
	N	Year	0	1	2	3	4	5
	a	Capital Investment	(30,000)
	b	Annual Benefits(After Tax)=9000*(1-0.3)		6,300	6,300	6,300	6,300	6,300
	c	Annual Depreciation Tax shield		6,000	2,000	400
	d	After tax salvage value						2,000
	CF=a+b+c+d	Net Cash Flow	(30,000)	12,300	8,300	6,700	6,300	8,300	SUM
	PV=CF/(1.12^N)	Present Value of Net Cash Flow	(30,000)	10,982	6,617	4,769	4,004	4,710	1,081
	NPV=Sum of PV	Present Worth	1,081
		PRESENT WORTH OF ALTERNATIVE A IS HIGHER
										Annual Depreciation =(9000-2000)/3 2333 Annual Depreciation Tax shield%32333*30% 700 CASH FLOW ANALYSIS OF ALTERNATIVE A Year 3 4 Capital Investment (9,000) a Annual Benefits(After Tax)=3000*(1-0.3) 2,142 2,229 2,100 2,185 2,273 Annual Depreciation Tax shield 700 700 700 d. After tax salvage value=2000*1.02^5 2,208 CF=a+b+c+d Net Cash Flow (9,000) 4,481 2,800 2,842 2,885 2,229 SUM 2,053 PV=CF/(1.12^N) Present Value of Net Cash Flow (9,000) 2,500 2,543 2,266 1,416 1,778 NPV=Sum of PV Present Worth 1,778 4.2 CONSIDERING INFLATION of 2% ALTERNATIVE B Year Beginning Book Value Depreciation rate=2*(1/3) Annual Depreciation Ending Book Value Annual Depreciation Tax shield 30000 10,000 3,333 B 66.67% 66.67% 66.67% C=A*B 20000 6667 1333 10000 D=A-B 3333 2000 E=C*30% 6000 2000 400 CASH FLOW ANALYSIS OF ALTERNATIVE B Year 3 4 Capital Investment (30,000) Annual Benefits(After Tax)=9000*(1-0.3) 6,300 6,426 6,555 6,686 6,819 Annual Depreciation Tax shield 400 6,000 2,000 d. After tax salvage value 2,208 CF=a+b+c+d (30,000) Net Cash Flow 12,300 8,426 6,955 6,686 9,027 SUM PV=CF/(1.12^N) Present Value of Net Cash Flow (30,000) 2,021 10,982 6,717 4,950 4,249 5,122 NPV=Sum of PV Present Worth 2,021 Present Worth of Alternative B is higher