Question

8 & 9

(15 pts) 8. Crowder Manufacturing, Inc. is considering the replacement of an existing machine. The new machine costs $750,000 and requires installation costs of $250,000. The existing machine can be sold currently for $300,000 before taxes. It is one year old, cost $600,000 new, and has a $500,000 book value and a remaining useful life of 5 years. Depreciation expense on the existing machine is $100,000 per year. Over its 5-year life, the new machine should reduce operating costs by $300,000 per year. The new machine will be depreciated on a straight- line basis to a zero salvage value over its 5-year life. The new machine can be sold for $100,000 net of removal and cleanup costs at the end of 5 years. An increased investment in not working capital of $100,000 will be needed to support operations if the new machine is acquired. The firm has a 16% cost of capital and is subject to a 25% tax rate. Should Crowder replace the existing machine? Show computations. (16 p.) 9. Robinson Enterprises is considering whether to pursue an aggressive or conservative current asset investment policy. The firm's annual sales are $4,000,000; its fixed assets are $2,000,000; debt and equity are each 50% of total assets. EBIT is $400,000, the interest rate on the firm's debt is 10%, and the firm's tax rate is 30%. With an aggressive policy, current assets will be 20% of sales. Under a conservative policy, current assets will be 60% of sales. Show computations. Required a) Determine the return on equity for the aggressive policy and the conservative policy b) Explain which policy you would recommend

Answer 1

Ques 8

Calculation of Cash Inflow for new Mach
Particular	Year 1	Year 2	Year 3	Year 4	Year 5
Saving in Operating Cost	300000	300000	300000	300000	300000
Add : Dep for new Machine	200000	200000	200000	200000	200000
Less : Dep for Old Machine	100000	100000	100000	100000	100000
Add : Sale of Machine					100000
Net Inflow Before tAx	400000	400000	400000	400000	500000
Less Tax @25%	100000	100000	100000	100000	125000
Net Inflow After Tax	300000	300000	300000	300000	375000
PV Factor @ 16%	0.9434	0.8900	0.8396	0.7921	0.7473
Present Value	283018.87	266998.93	251885.78	237628.10	280221.81

Particulars	New Machine	Old Machine
Cost of Machine	750000	600000
Installation Cost	250000	0
Working Capital Needed	100000	0
Less Sale of Old Machine	300000	300000
Add: Tax on Sale of mAch	81000	81000
Total Cash Outflow	881000	381000
PV of Cash Inflow	1319753.50	0
Net Present Value	438753.50	-381000.00

Conclusion : Crowder Manufacturer shall Consider replacing the old machinary with new one as it shows positive NPV

Que 9

a)
Particulars	Aggressive	Conservative
Sale	4000000	4000000
Current Asset(%)	20%	60%
Current Asset	800000	2400000
Fixed Asset	2000000	2000000
Capital Employed	2800000	4400000
Debt (50%)	1400000	2200000
Equity (50%)	1400000	2200000
EBIT	400000	400000
Less Interest @ 10%	140000	220000
EBT	260000	180000
Less Tax @30%	78000	54000
EAT	182000	126000
Return on Equity	6.50%	2.86%
(EAT/Captal Employed)

b) Recommendation: We would recommend agressive policy as it will provide higher return on equity . but besides this , we need to consider other facts also such as in aggresive policy the company would have less Current asset in hand and it may not be possible for the company to provide dividend inspite for higher return . Another factor to consider is that higher return will come with higher risk and wether the person is capable to take that risk.