Question

ERP has been operating a large

Platinum mine for many years. The company wants to acquire newly available equipment that will allow it to extract platinum ore from a currently inaccessible area of the mine. Cooper Sperrylite

ERP controller, has gathered the following data:

a.

The initial cost of the

extraction equipment is $2,500,000. In addition to this cost, the

equipment will require a large concrete foundation at a cost of $300,000. The vendor has

quoted an additional cost of $200,000 to install and test the equipment. These costs are all

considered part of the cost of acquiring the equipment.

b.The useful life of the equipment is 10 years with no salvage value at the end of this period.

However, for tax purposes, the equipment will be classified as 7year property and use the

following    MACRS    depreciation    allowances    (half year    convention)    for    computing    tax

depreciation deductions:

Percentage

Of Original

Year

Cost

1 . . . . . . . . . . 14.3%

2 . . . . . 24.5

3 . . . . . . . . . . 17.5

4 . . . . . . . . . . 12.5

5 . . . . . . . . . .   8.9

6 . . . . . . . . . .8.9

7 . . . . . . . . . .   8.9

8 . . . . . . . . . .4.5

100.0%

c.

Using the new equipment, 250 pounds of platinum can be extracted annually for the next 10

years from the previously inaccessible area of the mine.

d.The cost to extract and separate platinum from the ore is $4,000 per pound of platinum. After separation, the platinum must undergo further processing and testing that costs $1900 per pound of platinum. These are all out

of pocket, variable costs.

e.Two skilled technicians will be hired to operate the new equipment. The total salary and fringe

benefit expense for these two employees will be $200,000 annually over the 10 years.

f.Periodic maintenance on the equipment is expected to cost $175,000 per year.

g.The project requires an investment in additional working capital of $300,000. This working capital would be released for use elsewhere at the conclusion of the project in 10 years.

h.Environmental and safety regulations require that the mine be extensively restored and toxic

substances be safely disposed at the conclusion of the project.    The cost of environmental

remediation work is expected to be $4,500,000

i.The current market price of platinum is 12,800 per pound

j.The tax rate is 21% and it uses an 18% after tax discount rate (minimum required rate of return)

1. Depreciation tax shields and cash flow. Assume the platinum can be sold for $12,800 per pound. For years 1 through 8 compute the:
   1. A. Depreciation deductions
   2. B. After-tax cash flows
   3. C. Present value of after tax cash flows

1.		(a)		(b)		(c)
			(Depr Tax Shield)
		Depreciation		After-tax		Present Value of
	Year Ending	Deductions	Tax effect (%)	Cash Flows ($)	Discount Factor	Tax Shield ($)
	1	$       429,000	21%	$          90,090	0.8475	$             76,347
	2
	3
	4
	5
	6
	7
	8
	TOTALS	$       429,000				$             76,347

Answer 1

Depreciable basis = The initial cost of the extraction equipment + large concrete foundation cost + install and test cost of the equipment = $2,500,000 + $300,000 + $ 200,000 = 3,000,000

1		(a)		(b)		(c)
			(Depr Tax Shield)
		Depreciation		After-tax		Present Value of
Dep rate	Year Ending	Deductions	Tax effect (%)	Cash Flows ($)	Discount Factor	Tax Shield ($)
A	n	B = A x 3,000,000	T	C = B x T	D = (1 + 18%)-n	C x D
14.30%	1	429,000	21%	90,090	0.8475	76,347
24.50%	2	735,000	21%	154,350	0.7182	110,852
17.50%	3	525,000	21%	110,250	0.6086	67,102
12.50%	4	375,000	21%	78,750	0.5158	40,618
8.90%	5	267,000	21%	56,070	0.4371	24,509
8.90%	6	267,000	21%	56,070	0.3704	20,770
8.90%	7	267,000	21%	56,070	0.3139	17,602
4.50%	8	135,000	21%	28,350	0.2660	7,542
	TOTALS	3,000,000				365,342