Question

DataPoint Engineering is considering the purchase of a new piece of equipment for $255,000. It has an eight-year midpoint of its asset depreciation range (ADR). It will require an additional initial investment of $250,000 in nondepreciable working capital. Eighty-two thousand dollars of this investment will be recovered after the sixth year and will provide additional cash flow for that year. Income before depreciation and taxes for the next six are shown in the following table. Use Table 12-11 Table 12-12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. Year 3 4 Amount $242.000 198,000 168,000 153,000 114.000 104.000 6 The tax rate is 25 percent. The cost of capital must be computed based on the following: Weights Debt Preferred stock Common equity (retained earnings) Kd K ке Cost (aftertax) 6.40% 10.50 15.00 10 60 a. Determine the annual depreciation schedule. (Do not round intermediate calculations. Round your depreciation base and annual depreciation answers to the nearest whole dollar. Round your percentage depreciation answers to 3 decimal places.) Depreciation Base Year Percentage Depreciation 1 Annual Depreciation 1 b. Determine the annual cash flow for each year. Be sure to include the recovered working capital in Year 6. (Do not round intermediate calculations and round your answers to 2 decimal places.) Year Cash Flow 3 5

Answer 1

Answer -

a. Answer -

As per Table 12-11, An Eight-year midpoint of its asset depreciation range (ADR) leads to 5-year MACRS depreciation.

Year	Depreciation Base	Percentage Depreciation	Annual Depreciation
1	$255000	0.200	$51000
2	$255000	0.320	$81600
3	$255000	0.192	$48960
4	$255000	0.115	$29325
5	$255000	0.115	$29325
6	$255000	0.058	$14790
			$255000

b. Answer -

Year	Cash flow
1	$194250
2	$168900
3	$138240
4	$122081
5	$92831
6	$163698

Calculation:

Year	1	2	3	4	5	6
Earning before depreciation and tax (EBDT)	$242,000	$198,000	$168,000	$153,000	$114,000	$104,000
Less: Depreciation	$51,000	$81,600	$48,960	$29,325	$29,325	$14,790
Earning before tax (EBT)	$191,000	$116,400	$119,040	$123,675	$84,675	$89,210
Less: Tax (25%)	$47,750	$29,100	$29,760	$30,918.75	$21,168.75	$22,302.50
Earning after tax (EAT)	$143,250	$87,300	$89,280	$92,756.25	$63,506.25	$66,907.50
Add: Depreciation	$51,000	$81,600	$48,960	$29,325	$29,325	$14,790
Add: Recovery of working capital						$82,000
Cash flow	$194,250	$168,900	$138,240	$122,081.25	$92,831.25	$163,698.50

c. Answer -

Weighted average cost of capital

11.97%

Calculation:

	Cost (after tax) [A]	Weights [B]	Weighted [A * B]
Debt	6.40%	30%	1.92%
Preferred stock	10.50%	10%	1.05%
Common equity (retained earnings)	15%	60%	9.00%
Weighted cost of capital			11.97%

d-1. Answer -

Net present value

$114779.06

Calculation:

Year	Cash flow (Inflows)	PV at 12%	Present value
1	$194,250	0.893	$173,465.25
2	$168,900	0.797	$134,613.30
3	$138,240	0.712	$98,426.88
4	$122,081.25	0.636	$77,643.68
5	$92,831.25	0.567	$52,635.32
6	$163,697.50	0.507	$82,994.63
Present value of inflows			$619,779.06

Here,

Present value of outflows = Equipment + Initial working capital

Present value of outflows = $255000 + $250000 = $505000

So,

Net present value = Present value of inflows - Present value of outflows

Net present value = $619779.06 - $505000

Net present value = $114779.06

d-2. Answer -

Yes

The net present value ($114779.06) is positive and Data Point Engineering should purchase the equipment.