Question

Robinson Corporation currently processes seafood with a machine it purchased several years ago. The machine, which originally cost $1,000,000, currently has a book value of $400,000. Robinson is considering replacing the machine with a newer, more efficient one. The new machine will cost $1,400,000 and will require an additional $100,000 for delivery and installation. The new machine will also require Robinson to increase its investment in receivables and inventory by $400,000. The new machine will be depreciated on a straight-line basis over five years to a zero balance. Robinson expects to sell the existing machine for $300,000. Robinson’s marginal tax rate is 25 percent and the required rate of return for Robinson is 12 percent. If Robinson purchases the new machine, annual revenues are expected to increase by $200,000 and annual operating costs (exclusive of depreciation) are expected to decrease by $50,000. Annual revenue and operating costs are expected to remain constant at this new level over the five-year life of the project. After five years, the new machine will be completely depreciated and is expected to be sold for $200,000. (Assume that the existing unit is being depreciated at a rate of $80,000 per year.)

1. Determine the payback period of the project.

Answer 1

          
   in $      
Original Machine cost   1000000      
book value   400000      
   600000      
          
New Machine Cost   1400000      
Additional cost for delivery and installation   100000      
Amount required for New Machine   1500000      
          
Increase in working capital due to increase in inventory and receivables   400000      
Required rate of return    12%      
Marginal tax rate   25%      
          
          
Cashoutflow due to purchase of New Machine          
Amount required for New Machine   1500000      
Less:Sale value of Old Machine   300000      
Less:Tax benefit on sale of Old machine 25% on (400000-300000)   25000      
Net Cashoutflow due to purchase of New Machine   1175000      
          
Cashinflow due to New machine          
Increase in Annual revenues   200000      
Decrease in Operating cost   50000      
Net cashinflow    250000      
Marginal tax 25%   62500      
A.Net cashinflow before considering tax savings on deprication   187500      
          
Deprication   260000      
B.Tax savings on deprication   65000      
A+B Net cashinflow after taxes   252500      
          
Payback period   Net cash ouflow /Net cashinflow   4.65   Years