Question

HL Construction Co. plans to replace one of its manufacturing equipment for a newer more technology-advance one. The new equipment has a purchase price of $8,000 and will be depreciated as a 7-year class for MACRS. Installation costs for the new equipment are $200. It is estimated that this equipment can be sold in 4 years (end of project) for $5,000. This new equipment is more efficient than the existing one and thus savings before taxes using the new equipment are $4,000 a year. Because of the advance technology of new equipment, there will be a reduction in inventory of $400 today and which will be reverted at the end of the project in year 4. This existing equipment was purchased 2 years ago at a base price of $3,000. Installation costs at the time for this old equipment were $100. The existing equipment is considered also 7-year class for MACRS. The existing equipment can be sold today for $1,000 and for $0 in 4 years. The company's marginal tax rate is 30% and the cost of capital is 10%. MACRS Fixed Annual Expense Percentages by Recovery Class Year    3-Year    5-Year    7-Year    10-Year    15-Year 1    33.33%    20.00%    14.29%    10.00%    5.00% 2    44.45%    32.00%    24.49%    18.00%    9.50% 3    14.81%    19.20%    17.49%    14.40%    8.55% 4    7.41%    11.52%    12.49%    11.52%    7.70% 5        11.52%    8.93%    9.22%    6.93% 6        5.76%    8.93%    7.37%    6.23% 7            8.93%    6.55%    5.90% 8            4.45%    6.55%    5.90% 9                6.56%    5.91% 10                6.55%    5.90% 11                3.28%    5.91% 12                    5.90% 13                    5.91% 14                    5.90% 15                    5.91% 16                    2.95% For your answer, round to the nearest dollar, do not enter the $ sign, use commas to separate thousands, use a negative sign in front of first number is the cash flow is negative (do not use parenthesis to indicate negative cash flows). For example, if your answer is $3,005.87 then enter 3,006; if your answer is -$1,200.25 then enter -1,200

what is the projects initial cash flows (initial outlay) ay year 0?

Answer 1

Initial cash flows Purchase price Installation cost Sale value of existing equipment Change in working capital Reduction in Inventory level Initial outlay Year o $8,000 $200 $1,000 $400 $6,800 Working notes: $3,000 $100 $3,100 Existing equipment cost Installation cost Total asset cost Depreciation for Year 1 Year 2 Book value at end of year 2 $443 $759 $1,898 14.29% of asset cost 24.49% of asset cost Note: There is no capital gains tax since sale value of asset is lower than book value of asset at end of year 2