Question

Philadelphia Fastener Corporation manufactures nails, screws, bolts, and other fasteners. Management is considering a proposal to acquire new material-handling equipment. The new equipment has the same capacity as the current equipment but will provide operating efficiencies in labor and power usage. The savings in operating costs are estimated at $150,000 annually.

The new equipment will cost $300,000 and will be purchased at the beginning of the year when the project is started. The equipment dealer is certain that the equipment will be operational during the second quarter of the year it is installed. Therefore, 60 percent of the estimated annual savings can be obtained in the first year. The company will incur a one-time expense of $30,000 to transfer production activities from the old equipment to the new equipment. No loss of sales will occur, however, because the processing facility is large enough to install the new equipment without interfering with the operations of the current equipment. The equipment is in the MACRS 7-year property class. The firm would depreciate the machinery in accordance with the MACRS depreciation schedule.

The current equipment has been fully depreciated. Management has reviewed its condition and has concluded that it can be used an additional eight years. The company would receive $10,000, net of removal costs, if it elected to buy the new equipment and dispose of its current equipment at this time. The new equipment will have no salvage value at the end of its life. The company is subject to a 40 percent income-tax rate and requires an after-tax return of at least 12 percent on any investment.

Use Appendix A and Exhibit 16-9 for your reference. (Use appropriate factor(s) from the tables provided.)

Future Value and Present Value Tables Table 1 Future Value of $1.00(1 + in Period 4% 14% 20% 8% 1.080 1.166 1.260 1.361 1.040 1.082 1.125 1.170 1.217 1.265 1.316 1.369 1.423 1.480 1.540 1.601 1.665 1.732 1.801 2.191 3.243 4.801 6% 1.060 1.124 1.191 1.263 1.338 1.419 1.504 1.594 1.690 1.791 1.898 2.012 2.133 2.261 2.397 3.207 5.744 10.286 1.469 1.587 1.714 1.851 1.999 2.159 2.332 2.518 2.720 2.937 3.172 4.661 10.063 21.725 10% 1.100 1.210 1.331 1.464 1.611 1.772 1.949 2.144 2.359 2.594 2.853 3.139 3.452 3.798 4.177 6.728 17.450 45.260 12% 1.120 1.254 1.405 1.574 1.762 1.974 2.211 2.476 2.773 3.106 3.479 3.896 4.364 4.887 5.474 9.646 29.960 93.051 1.140 1.300 1.482 1.689 1.925 2.195 2.502 2.853 3.252 3.707 4.226 4.818 5.492 6.261 7.138 13.743 50.950 188.880 1.200 1.440 1.728 2.074 2.488 2.986 3.583 4.300 5.160 6.192 7.430 8.916 10.699 12.839 15.407 38.338 237.380 ,469.800 1 Period 4% 6% 8% 10% 12% 14% 20% Table II Future Value of a Series of $1.00 Cash Flows (Ordinary Annuity) (1 + 1" - 1 1.000 2.220 3.640 5.368 7.442 1.000 2.040 3.122 4.247 5.416 6.633 7.898 9.214 10.583 12.006 13.486 15.026 16.627 18.292 20.024 29.778 56.085 96.026 1.000 2.060 3.184 4.375 5.637 6.975 8.394 9.898 11.491 13.181 14.972 16.870 18.882 21.015 23.276 36.778 79.058 154.762 1.000 2.080 3.246 4.506 5.867 7.336 8.923 10.637 12.488 14.487 16.646 18.977 21.495 24.215 27.152 45.762 113.283 259.057 1.000 2.100 3.310 4.641 6.105 7.716 9.487 11.436 13.580 15.938 18.531 21.385 24.523 27.976 31.773 57.276 164.496 442.597 1.000 2.120 3.374 4.779 6.353 8.115 10.089 12.300 14.776 17.549 20.655 24.133 28.029 32.393 37.280 1.000 2.140 3.440 4.921 6.610 8.536 10.730 13.233 16.085 19.337 23.045 27.271 32.089 9.900 12.916 16.499 20.799 25.959 32.150 39.580 48.497 59.196 72.035 186.690 1,181.900 7,343.900 37.581 75.052 43.842 91.025 356.790 1,342.000 241.330 767.090 40 Table III Present Value of $1.00 (1 + )" Period 26% 28% 30% 32% .758 12% .893 .797 712 .636 14% 877 .769 .675 592 16% 862 .743 .641 552 574 781 .610 477 373 769 .592 455 .350 -567 .519 476 9 10 4% 962 .925 889 .855 .822 790 .760 .731 703 .676 .650 .625 .601 .577 .555 .456 .308 208 6% 943 .890 .840 792 .747 .705 .665 .627 592 558 .527 497 469 442 .417 312 174 .097 8% 926 857 .794 735 .681 .630 .583 540 500 463 429 397 368 340 315 215 .099 .046 10% 909 .826 751 .683 .621 564 .513 467 424 386 350 .319 290 263 239 149 .057 .022 507 452 404 361 322 287 257 229 205 .183 104 .033 .011 456 400 351 .308 2 70 237 208 182 .160 .140 .073 .020 .005 410 .354 305 263 227 195 168 145 .125 .108 .051 .012 .003 18% 847 .718 .609 .516 .437 370 .314 266 225 191 162 137 116 .099 .084 .037 .007 .001 20% 833 .694 579 482 402 335 279 233 194 162 .135 112 .093 .078 .065 .026 .004 .001 22% 820 .672 .551 451 .370 303 249 204 167 137 .112 .092 .075 .062 .051 019 .003 - 24% 806 .650 524 423 341 275 .222 .179 144 116 .094 .076 .061 .049 .040 014 .002 - 7 94 .630 .500 .397 .315 250 .198 .157 125 099 .079 062 .050 .039 .031 010 .001 - 227 .178 139 108 085 .066 .052 .040 .032 .025 .007 .001 - 207 .159 .123 .094 .073 .056 .043 .033 .025 .020 .005 - 435 329 .250 189 .143 108 082 062 047 036 .027 021 .016 .004 13 14 15 Table IV Present Value of Series of $1.00 Cash Flows 111 - 1 71 (1 + r) Period 4% 6% 8% 10% 12% 14% 16% 18% 20% 22% 24% 25% 26% 28% 30% 2 3 6 4 0.962 1.886 2.775 3.630 4.452 5.242 6.002 6.733 7.435 8.111 8.760 9.385 0.943 0.926 0.909 1.833 1.783 1.736 2.673 2.577 2.487 3.465 3.312 3.170 4.212 3.993 3.791 .917 4.623 4.355 5.5825.206 4.868 6.210 5.747 5.335 6.802 6.247 5.759 7.360 6.710 6.145 7.887 7.139 6.495 8.384 7.536 6.814 8.853 7.904 7.103 9.295 8.244 7.367 9.712 8.5597.606 11.470 9.818 8.514 13.765 11.258 9.427 15.046 11.925 9.779 0.89 1.690 2.402 3.037 3.606 4.111 4.564 4.968 5.328 5.650 5.938 6.194 6.424 6.628 6.811 7.469 8.055 8.244 0.877 1.647 2.322 2.914 3.433 3.889 4.288 4.639 4.946 5.216 5.453 5.660 5.842 6.002 6.142 6.623 7.003 7.105 0.862 1.605 2.246 2.798 3.274 3.685 4.039 4.344 4.607 4.833 5.029 5.197 5.342 5.468 5.575 5.929 6.177 6.234 0.847 1.566 2.174 2.690 3.127 3.498 3.812 4.078 4.303 4.494 4.656 4.793 4.910 5.008 5.092 5.353 5.517 5.548 0.833 0.820 1.528 1.492 2.106 2.042 2.589 2.494 2.991 2.864 3.326 3.167 3.605 3.416 3.837 3.619 4.031 3.786 4.1923.923 4.327 4.035 4.4394.127 4.533 4.203 4.611 4.265 4.675 4.315 4.870 4.460 4.979 4.534 4.997 4.544 0.806 0.800 1.457 1.440 1.981 1.952 2.404 2.362 2.745 2.689 3.020 2.951 3.2423.161 3.421 3.329 3.566 3.463 3.682 3.571 3.776 3.656 3.851 3.725 3.912 3.780 3.962 3.824 4.001 3.859 4.110 3.954 4.160 3.995 4.166 3.999 0.794 1.424 1.923 2.320 2.635 2.885 3.083 3.241 3.366 3.465 3.544 3.606 3.656 3.695 3.726 3.808 3.842 3.846 0.781 1.392 1.868 2.241 2.532 2.759 2.937 3.076 3.184 3.269 3.335 3.387 3.427 3.459 3.483 3.546 3.569 3.571 0.769 1.361 1.816 2.166 2.436 2.643 2.802 2.925 3.019 3.092 3.147 3.190 3.223 3.249 3.268 3.316 3.332 3.333 11 20 10.563 11.118 13.590 17.292 19.793 40

Required:

1. 1.Calculate the annual incremental after-tax cash flows for Philadelphia Fastener Corporation’s proposal to acquire the new equipment.

2. 2-a. Calculate the net present value of the proposal to acquire the new equipment using the cash flows calculated in requirement (1), Assume all cash flows take place at the end of the year.

I really need part 2-a answered! This question has been asked before, but it keeps getting answered incorrectly.

Answer 1

Value given
Cost of new equipment = $ 300,000
One time expenses = $ 30,000 ( assumed that it is not added to cost of equipment)
Receipt from disposal of old asset = $ 10,000
Estimated annual operation savings = $ 150,000
Estimated annual operation savings in Year 1 = $ 150,000 * 60% = $ 90,000
Tax rate = 40%
Required rate of return = 12%
Since, the tax rate is 40%, the savings after tax would be
= Savings * ( 1- tax rate)
After tax savings for year 1 = $ 90,000 * (1 - 0.40)
= $ 90,000 * 0.60
= $ 54,000
After tax savings for year 2 to year 7 = $ 150,000 * (1 - 0.40)
= $ 150,000 * 0.60
= $ 90,000
After tax cash - outflow on one time expenses = $ 30,000 * (1 - 0.40)
= $ 30,000 * 0.60
= $ 18,000
Computation of depreciation using MACRS depreciation schedule as provided
Year	Adjusted Basis	Rate %	Depreciation	Cumulative	Book Value
Year 1	$300,000	14.29%	$42,870	$42,870	$257,130
Year 2	$257,130	24.49%	$73,470	$116,340	$183,660
Year 3	$183,660	17.49%	$52,470	$168,810	$131,190
Year 4	$131,190	12.49%	$37,470	$206,280	$93,720
Year 5	$93,720	8.93%	$26,790	$233,070	$66,930
Year 6	$66,930	8.92%	$26,760	$259,830	$40,170
Year 7	$40,170	8.93%	$26,790	$286,620	$13,380
Year 8	$13,380	4.46%	$13,380	$300,000	$0
1.
After tax cash flow = After tax cost savings + Depreciation
Annual Incremental after-tax cash flow
Year	After tax Income	Depreciation	Cash Flow
Year 1	$54,000	$42,870	$96,870
Year 2	$90,000	$73,470	$163,470
Year 3	$90,000	$52,470	$142,470
Year 4	$90,000	$37,470	$127,470
Year 5	$90,000	$26,790	$116,790
Year 6	$90,000	$26,760	$116,760
Year 7	$90,000	$26,790	$116,790
Year 8	$0	$13,380	$13,380
Total after-tax cash flow			$894,000
Total incremental after tax cash flow
After tax cash flow					$894,000
Add:Net receipt from disposal of old equipment					$10,000
Less:After tax cash flow on One time expenses					($18,000)
Total incremental after tax cash flow					$886,000
(2-a) Computation of Net Present Value of proposal
After tax cash flow = After tax cost savings + Depreciation
Year	After tax Income	Depreciation	Salvage Value	Cash Flow	PV Factor for 12%	Present Value
Year 1	$54,000	$42,870		$96,870	0.893	$86,505
Year 2	$90,000	$73,470		$163,470	0.797	$130,286
Year 3	$90,000	$52,470		$142,470	0.712	$101,439
Year 4	$90,000	$37,470		$127,470	0.636	$81,071
Year 5	$90,000	$26,790		$116,790	0.567	$66,220
Year 6	$90,000	$26,760		$116,760	0.507	$59,197
Year 7	$90,000	$26,790	$13,380	$130,170	0.456	$59,358
Total				$894,000		$584,076
Note on Salvage Value
The machine has no salvage value,but since we are using the half year convention, the
closing book value of the machine at the end of the Year 7 would be considered as
salvage value to determine the cash flow for year 7.Since, the machinery has useful life
of 7 years as assumed due to the adoption MACRS 7 year depreciation schedule,there
would be no cash flow from the cost savings after the Year 7
Computation of Net present value
Present Value of Cash Flow					$584,076
Initial Value of Cash Outflow(refer note below)					($308,000)
Net Present Value					$276,076
Initial Value of Cash Outflow
Cost of new equipment					$300,000
Add:After tax cash flow on One time expenses					$18,000
Less:Net receipt from disposal of old equipment					($10,000)
Initial Value of Cash Outflow					$308,000