Question

Bloomington Manufacturing Company is considering the purchase of equipment to expand its productive capacity. The equipment is expected to generate the following cash revenues and expenses over its useful life. Year 1 2 BLOOMINGTON MANUFACTURING COMPANY DATA FOR CAPITAL BUDGETING ANALYSIS-EQUIPMENT Cash Revenues Cash Expenses $ 30,000 $ 40,000 50,000 40,000 30,000 20,000 22,000 25,000 20,000 20,000 The cost of the equipment is $60,000 and the equipment is expected to have a salvage value of $6,000. The company uses 200% (double) declining balance depreciation for all equipment. The company requires a minimum rate of return after tax of 11% and a maximum payback period of 4 years on its capital investment purchases. The company has a marginal tax rate of 30%.

Answer 1

(2): Let us first make a depreciation schedule. The annual depreciation rate = 100%/5 years * 2 = 40% per year

Year	Opening balance	Depreciation (40%)	Closing balance
1	60,000	24,000	36,000
2	36,000	14,400	21,600
3	21,600	8,640	12,960
4	12,960	5,184	7,776
5	7,776	1,776	6,000

Now let us compute the after tax cash flows and operating cash flow:

	YEAR
	1	2	3	4	5
Revenue	30,000.00	40,000.00	50,000.00	40,000.00	30,000.00
Expenses	20,000.00	22,000.00	25,000.00	20,000.00	20,000.00
Depreciation	24,000.00	14,400.00	8,640.00	5,184.00	1,776.00
EBIT	- 14,000.00	3,600.00	16,360.00	14,816.00	8,224.00
Tax (tax shield) 30%	4,200.00	-   1,080.00	-   4,908.00	-   4,444.80	-   2,467.20
Net income	-   9,800.00	2,520.00	11,452.00	10,371.20	5,756.80
EBIT	- 14,000.00	3,600.00	16,360.00	14,816.00	8,224.00
Depreciation	24,000.00	14,400.00	8,640.00	5,184.00	1,776.00
Tax (tax shield) 30%	4,200.00	-   1,080.00	-   4,908.00	-   4,444.80	-   2,467.20
Operating cash flow	14,200.00	16,920.00	20,092.00	15,555.20	7,532.80

Next we compute total cash flow:

	YEAR
	0	1	2	3	4	5
Operating cash flow		14,200.00	16,920.00	20,092.00	15,555.20	7,532.80
Capital spending	- 60,000.00					6,000.00
Total cash flow	- 60,000.00	14,200.00	16,920.00	20,092.00	15,555.20	13,532.80

Thus after tax payback:

Year	Cash flow	Cumulative cash flow
0	-                 60,000.00	-                           60,000.00
1	14,200.00	-                           45,800.00
2	16,920.00	-                           28,880.00
3	20,092.00	-                             8,788.00
4	15,555.20	6,767.20
5	13,532.80

Thus after tax payback = 3 + (8788/15555.20) = 3.56 years

(3): NPV:

Year	Cash flow	1+r	PVIF	PV
0	-                 60,000.00	1.11	1.0000	- 60,000.00
1	14,200.00		0.9009	12,792.79
2	16,920.00		0.8116	13,732.65
3	20,092.00		0.7312	14,691.10
4	15,555.20		0.6587	10,246.69
5	13,532.80		0.5935	8,031.06
			NPV	-       505.71

NPV = - $ 505.71