Question

Lasting Impressions (LI) Company is a medium-sized commercial printer of pro- motional advertising brochures, booklets, and other direct-mail pieces. The firm's major clients are ad agencies based in New York and Chicago. The typical job is characterized by high quality and production runs of more than 50,000 units. LI has not been able to compete effectively with larger printers because of its existing older inefficient presses. The firm is currently having problems meeting run length requirements as well as meeting quality standards in a cost-effective manner The general manager has proposed the purchase of one of two large, six-color presses designed for long, high-quality runs. The purchase of a new press would en- able LI to reduce its cost of labor and therefore the price to the client, putting the firm in a more competitive position. The key financial characteristics of the old press and of the two proposed presses are summarized in what follows. Old press: Originally purchased 3 years ago at an installed cost of $400,000, it is being depreciated under MACRS using a 5-year recovery period. The old press has a remaining economic life of 5 years. It can be sold today to net $420,000 before taxes; if it is retained, it can be sold to net $150,000 before taxes at the end of 5 years Press A: This highly automated press can be purchased for $830,000 and will require $40,000 in installation costs. It will be depreciated under MACRS using a 5-year recovery period. At the end of the 5 years, the machine could be sold to net $400,000 before taxes. If this machine is acquired, it is anticipated that the current account changes shown in the following table would result. Cash Accounts receivable +$25,400 +$120,000 Inventories $20,000 +$35,000 Accounts payable Press B: This press is not as sophisticated as press A. It costs $640,000 and requires $20,000 in installation costs. It will be depreciated under MACRS using a 5-year recovery period. At the end of 5 years, it can be sold to net $330,000 before taxes. Acquisition of this press will have no effect on the firm's net working capital investment.

Answer 1

0
	b	DEPRECIATION OF OLD PRESS
		Year (From the date of installation)	1	2	3	4	5	6
	A	Depreciation Rate	20.00%	32.00%	19.20%	11.52%	11.52%	5.76%
	B=A*400000	Annual Depreciation	$80,000	$128,000	$76,800	$46,080	$46,080	$23,040
	C	Accumulated Depreciation	$80,000	$208,000	$284,800	$330,880	$376,960	$400,000
	D=400000-C		$320,000	$192,000	$115,200	$69,120	$23,040	$0
		Book Value of old machine now (Year3)	$115,200
		Salvage value of old machine now	$420,000
		Gain on salvage	$304,800	(420000-115200)
		Tax on gain =304800*40%	$121,920
		After tax Cash flow on salvage of old machine now	$298,080	(420000-121920)
		After tax salvage value at the end of 5 years from today	$90,000	150000*(1-0.4)
		ANALYSIS OF REPLACEMENT BY PRESS A
		Initial Investment:
		Cost of new Press	$830,000
		installation cost	$40,000
	a	Total Depreciable asset	$870,000
		Increase in net working Capital:
		Cash	$25,400
		Accounts receivable	$120,000
		Inventories	($20,000)
		Accounts Payable	($35,000)
	b	Increase in net working Capital:	$90,400
	c	Net Salvage cashflow from old press now	$298,080
	d=a+b-c	Initial Investment	$662,320
		DEPRECIATION OF NEW PRESS A
		Year(from today)	1	2	3	4	5	6
	A	Depreciation of OLD PRESS	$46,080	$46,080	$23,040	$0	$0
	B	Depreciation Rate	20.00%	32.00%	19.20%	11.52%	11.52%	5.76%
	C=B*$870000	Depreciation amount	$174,000	$278,400	$167,040	$100,224	$100,224	$50,112
	D=C-A	Incremental in annual depreciation expense	$127,920	$232,320	$144,000	$100,224	$100,224
		Salvage Value of new Press A(Before Tax)	$400,000
		Book Value at end of year5	$50,112
		Gain on Salvage	$349,888	(400000-50112)
		Tax on Gain =349888*40%	$139,955
		After tax Salvage cash flow=400000-139955	$260,045
		Salvage Value of old machine at end of 5 years	$90,000
		Incremental Salvage cash flow	$170,045	(260045-90000)
										E=D*40% HEG-F I=H*(1-0.4) J=E+I Present value of Cash Flow=(Cash Flow)/((1+i)^N) i-discount Rate =Cost of capital =14%=0.14 N=Year of Cash Flow Year From Today Incremental Depreciation tax shield $51,168 EBITD of old press $120,000 EBITD of New Press A $250,000 Increase in EBITD $130,000 After tax increase in earning (excluding depreciation) $78,000 Incremental Annual Cash Inflow $129,168 Incremental Salvage cash flow Net Incremental Cash Inflow $129,168 Present Value of Cash Inflow $113,305 Sumof Present Value of Cash inflows $562,903 Initial Investment: $662,320 Net Present value $99,417 NPV is NEGATIVE 5 $92,928 $57,600 $40,090 $40,090 $120,000 $120,000 $120,000 $120,000 $270,000 $300,000 $330,000 $370,000 $150,000 $180,000 $210,000 $250,000 $90,000 $108,000 $126,000 $150,000 $182,928 $165,600 $166,090 $190,090 $170,045 $182,928 $165,600 $166,090 $360,134 SUM $140,757 $111,775 $98,338 $98,727 $562,903 LEJ+K M=L/(1.14N) PV NPV=PV-1 ANALYSIS OF REPLACEMENT BY PRESS B Initial Investment: Cost of new Press installation cost Total Depreciable asset Net Salvage cashflow from old press now Initial Investment $640,000 $ 20,000 $660,000 $298,080 $361,920 d=a-c 2 3 $46,080 $23,040 32.00% 19.20% $211,200 $126,720 $165,120 $103,680 $0 11.52% $76,032 $76,032 5 6 $0 $0 11.52% 5.76% $76,032 $38,016 $76,032 C=B*$660000 DEC-A DEPRECIATION OF NEW PRESS B Year(from today) 1 Depreciation of OLD PRESS $46,080 Depreciation Rate 20.00% Depreciation amount $132,000 Incremental in annual depreciation expense $85,920 Salvage Value of new Press B(Before Tax) $330,000 Book Value at end of years $38,016 Gain on Salvage $291,984 Tax on Gain =291984*40% $116,794 After tax Salvage cash flow=330000-116794 $213,206 Salvage Value of old machine at end of 5 years $90,000 Incremental Salvage cash flow $123,206 (330000-38016) (213206-90000) 5 E=D*40% HEG-F I=H*(1-0.4) J=E+I Present value of Cash Flow=(Cash Flow)/((1+i)^N) i-discount Rate =Cost of capital =14%=0.14 N=Year of Cash Flow Year From Today Incremental Depreciation tax shield $34,368 EBITD of old press $120,000 EBITD of New Press B $210,000 Increase in EBITD $90,000 After tax increase in earning (excluding depreciation) $54,000 Incremental Annual Cash Inflow $88,368 Incremental Salvage cash flow Net Incremental Cash Inflow $88,368 Present Value of Cash Inflow $77,516 Sumof Present Value of Cash inflows $328,150 Initial Investment: $361,920 Net Present value -$33,770 NPV is NEGATIVE $ 66,048 $41,472 $30,413 $30,413 $120,000 $120,000 $120,000 $120,000 $210,000 $210,000 $210,000 $210,000 $90,000 $90,000 $90,000 $90,000 $54,000 $54,000 $54,000 $54,000 $120,048 $95,472 $84,413 $84,413 $123,206 $120,048 $95,472 $84,413 $207,619 SUM $92,373 $64,441 $49,979 $43,841 $328,150 LEJ+K M=L/(1.14^N) PV NPV=PV-1