Question

A firm is considering purchasing new manufacturing equipment with a useful life of 5 years and a MACRS life of 3 Years. The cost of the new equipment is $62,400. The firm will dispose of existing equipment with an original cost of $29,000 and a book value of $12,000. The old equipment is becoming obsolete, and can only be sold for $9,000. The firm expects pre-tax cost reductions as a result of using this new equipment of $12,300 per year. Prior to considering this equipment, the firm spent $500 in consulting fees in order to assure the feasibility of using the equipment. These funds cannot be recovered. The new equipment will need to occupy space currently leased to a third party for $1,100 per year (before taxes). The firm's marginal tax rate is 22%, its WACC is 8.4% 1) Calculate the net incremental cash flows for each of the years of the asset's useful life in the space provided on the following page (round to nearest dollar) 2) Calculate the NPV for the project: Show all work: 3) Calculate the Profitability Index for the project: (round to two decimals) Show all work: Continued...

Please show any and all work or sub-calculations.

Answer 1

Tax rate		22%
Calculation of after-tax salvage value of old equipment
Cost of machine			$             29,000
Depreciation			$             17,000
WDV			$             12,000
Sale price			$               9,000
Profit/(Loss)			$             (3,000)
Tax			$                 (660)
Sale price after-tax			$               9,660
Calculation of annual depreciation
Depreciation		Year-1	Year-2	Year-3	Year-4	Year-5	Total
Cost		$             62,400	$             62,400	$             62,400	$             62,400	$             62,400
Dep Rate		30.00%	40.00%	20.00%	10.00%
Depreciation		$             18,720	$             24,960	$             12,480	$                6,240	$                      -	$             62,400
Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4	Year-5
Cost reduction		$             12,300	$             12,300	$             12,300	$             12,300	$             12,300
Lease rent lost		$                1,100	$               1,100	$                1,100	$                1,100	$               1,100
Contribution		$             11,200	$            11,200	$             11,200	$             11,200	$             11,200
Less: Depreciation		$             18,720	$             24,960	$             12,480	$                6,240	$                      -
Profit before tax		$             (7,520)	$          (13,760)	$             (1,280)	$               4,960	$             11,200
Tax @ 22%		(1,654)	(3,027)	(282)	1,091	2,464
Profit After Tax		$             (5,866)	$          (10,733)	$                 (998)	$               3,869	$               8,736
Add Depreciation		$             18,720	$             24,960	$             12,480	$                6,240	$                      -
Cash Profit after-tax		$             12,854	$            14,227	$             11,482	$             10,109	$               8,736
Calculation of NPV
						8.40%
Year		Capital	After tax salvage value	Operating cash	Annual Cash flow	PV factor	Present values
0		$            (62,400)	$               9,660		$            (52,740)	1.0000	$            (52,740)
1				$             12,854	$             12,854	0.9225	$             11,858
2				$             14,227	$             14,227	0.8510	$             12,108
3				$             11,482	$             11,482	0.7851	$                9,014
4				$             10,109	$             10,109	0.7242	$                7,321
5		$                      -		$                8,736	$                8,736	0.6681	$                5,837
					Net Present Value		$             (6,602)
Calculation of profitability index
Profitability index=	PV of inflows/outflow
Profitability index=	46138/52740
Profitability index=	0.87