Question

Universal Electronics is considering the purchase of manufacturing equipment with a 10-year midpoint in its asset depreciation range (ADR). Carefully refer to Table 12-11 to determine in what depreciation category the asset falls. (Hint: It is not 10 years.) The asset will cost $210,000, and it will produce earnings before depreciation and taxes of $68,000 per year for three years, and then $31,000 a year for seven more years. The firm has a tax rate of 35 percent. Assume the cost of capital is 13 percent. In doing your analysis. If you have years in which there is no depreciation, merely enter a zero for depreciation. Use Table 12-12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods a. Calculate the net present value. (Do not round intermediate calculations and round your answer to 2 decimal places.) Net present value b. Based on the net present value, should Universal Electronics purchase the asset? Yes No

Answer 1

The manufacturing equipment has 10-year midpoint ADR, thus the depreciation would be written off based on 7-year MACRS.
This is because this category has assets with useful life of 10 years or more and includes manufacturing equipment.
Net present value	Present value of cash inflow - Present value of cash outflow
Calculation of net present value is shown below
Year	0	1	2	3	4	5	6	7	8	9	10
Earnings before depreciation and taxes		$68,000	$68,000	$68,000	$31,000	$31,000	$31,000	$31,000	$31,000	$31,000	$31,000
Less: Depreciation		$30,030	$51,450	$36,750	$26,250	$18,690	$18,690	$18,690	$9,450
Earnings before taxes		$37,970	$16,550	$31,250	$4,750	$12,310	$12,310	$12,310	$21,550	$31,000	$31,000
Less: Taxes @ 35%		$13,289.50	$5,792.50	$10,937.50	$1,662.50	$4,308.50	$4,308.50	$4,308.50	$7,542.50	$10,850.00	$10,850.00
Net income		$24,681	$10,758	$20,313	$3,088	$8,002	$8,002	$8,002	$14,008	$20,150	$20,150
Add: Depreciation		$30,030	$51,450	$36,750	$26,250	$18,690	$18,690	$18,690	$9,450	$0	$0
Cash flow		$54,711	$62,208	$57,063	$29,338	$26,692	$26,692	$26,692	$23,458	$20,150	$20,150
Purchase of equipment	-$210,000
Net cash flow	-$210,000	$54,711	$62,208	$57,063	$29,338	$26,692	$26,692	$26,692	$23,458	$20,150	$20,150
Discount factor @ 13% (1/(1.13^n))	$1.00000	$0.88496	$0.78315	$0.69305	$0.61332	$0.54276	$0.48032	$0.42506	$0.37616	$0.33288	$0.29459
Present value	-$210,000.00	$48,416.37	$48,717.60	$39,547.17	$17,993.24	$14,487.08	$12,820.42	$11,345.51	$8,823.77	$6,707.63	$5,935.96
Net present value	$4,794.74
We have calculated net present value using formula.
Yes, Company should purchase the machine as NPV is positive.
Depreciation on asset
Year 1	210000*0.143	$30,030
Year 2	210000*0.245	$51,450
Year 3	210000*0.175	$36,750
Year 4	210000*0.125	$26,250
Year 5	210000*0.089	$18,690
Year 6	210000*0.089	$18,690
Year 7	210000*0.089	$18,690
Year 8	210000*0.045	$9,450