A risk manager is considering the installation of new safety guards for the machines in the stamping process. The guards have an expected lifetime of 8 years and cost $250,000 to install. The presence of the guards have 3 negative effects: they increase annual maintenance costs by $5200 a year for the first 6 years and by $6000 a year for the last 2 years (because the machines are more difficult to service) and they increase production cost by $11,000 a year (because workers produce less output once the guards are installed). Both these expenses are realized at year end. Finally there is a training cost of $1000 a year at the beginning of the year to ensure that workers
Each year of their life, the guards are expected to reduce the employer’s retained work-injury costs and expenses related to employees injuring themselves on the production line by $10,000. These savings are realised at the end of each year. In addition the employer’s worker’s compensation insurance is willing to reduce the premium for coverage by $44,000 a year (payable at the beginning of the year) if the guards are installed. The employer faces a 34% tax rate on income and straight-line depreciation is used for the safety guards.
a)
0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | |
Setup Cost | 250000 | ||||||||
Maintenance Cost | 5200 | 5200 | 5200 | 5200 | 5200 | 5200 | 6000 | 6000 | |
Production Cost | 11000 | 11000 | 11000 | 11000 | 11000 | 11000 | 11000 | 11000 | |
Training Cost | 1000 | 1000 | 1000 | 1000 | 1000 | 1000 | 1000 | 1000 | |
Injury Expense Saving | 10000 | 10000 | 10000 | 10000 | 10000 | 10000 | 10000 | 10000 | |
Insurance Savings | 44000 | 44000 | 44000 | 44000 | 44000 | 44000 | 44000 | 44000 | |
Depreciation Adjustment | 31250 | 31250 | 31250 | 31250 | 31250 | 31250 | 31250 | 31250 | |
Taxable Income | 5550 | 5550 | 5550 | 5550 | 5550 | 5550 | 4750 | 4750 | |
Tax Rate 34% | 1887 | 1887 | 1887 | 1887 | 1887 | 1887 | 1615 | 1615 | |
After Tax Cashflow | -215087 | 34913 | 34913 | 34913 | 34913 | 34913 | 34385 | 34385 |
b) At 9% the NPV is -35896, but if we consider that firm has enough tax to be paid already then we can add the increased cashflow of tax payouts to the project. We don't use this for calculating post annual tax cash flows of earlier part as for project finance we consider only the project impact. But for decision of go no go we can consider the impact of tax as well. With that adjusted NPV will be $22910.52.
0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | |
Setup Cost | 250000 | ||||||||
Maintenance Cost | 5200 | 5200 | 5200 | 5200 | 5200 | 5200 | 6000 | 6000 | |
Production Cost | 11000 | 11000 | 11000 | 11000 | 11000 | 11000 | 11000 | 11000 | |
Training Cost | 1000 | 1000 | 1000 | 1000 | 1000 | 1000 | 1000 | 1000 | |
Injury Expense Saving | 10000 | 10000 | 10000 | 10000 | 10000 | 10000 | 10000 | 10000 | |
Insurance Savings | 44000 | 44000 | 44000 | 44000 | 44000 | 44000 | 44000 | 44000 | |
Depreciation Adjustment | 31250 | 31250 | 31250 | 31250 | 31250 | 31250 | 31250 | 31250 | |
Taxable Income | 5550 | 5550 | 5550 | 5550 | 5550 | 5550 | 4750 | 4750 | |
Tax Rate 34% | 1887 | 1887 | 1887 | 1887 | 1887 | 1887 | 1615 | 1615 | |
After Tax Cashflow | -215087 | 34913 | 34913 | 34913 | 34913 | 34913 | 34385 | 34385 | |
Wacc 9% | 1 | 0.917431 | 0.84168 | 0.772183 | 0.708425 | 0.649931 | 0.596267 | 0.547034 | 0.501866 |
Time Value | -207000 | 32030.28 | 29385.57 | 26959.24 | 24733.25 | 22691.05 | 20817.48 | 18809.77 | -4323.58 |
Cashflow with Tax impact of depreciation | 41777.98 | 38328.42 | 35163.69 | 32260.27 | 29596.58 | 27152.82 | 24622.01 | 1008.751 | |
NPV | -35896.9 | ||||||||
Adjusted NPV | 22910.52 |
c) As we have assumed the cost of capital for discounting it implies that we are considering to finance it in the same proportion of debt and equity as the WACC. In such case the installation shall have no impact on WACC. But in reality its difficult to maintain such ratio, and if financing for the project is done through some other source of funds then cost of capital gets impacts accordingly.
A risk manager is considering the installation of new safety guards for the machines in the...
Heron Corporation is planning to add manufacturing capacity by installing new high-tech machines. The machines would increase revenues by $180,000 per year and increase costs by $50,000 per year. The new machines cost $560,000 and would be depreciated over 5 years using simplified straight line. Investment in net working capital of $30,000 would be required at the time of installation. The firm is planning to keep the machines for 7 years and then sell them for $80,000. The firm has...
Read Book Company is the manufacturer of exercise machines and is considering producing a new line of equipment in an effort to increase its market share. The new production line will cost $850,000 for manufacturing the parts and an additional $280,000 is needed for installation. The equipment falls into the MACRS 3-yr class and would be sold after four years for $350,000. The equipment line will generate additional annual revenues of $600,000 and will have additional annual operating expenses of...
Read Book Company is the manufacturer of exercise machines and is considering producing a new line of equipment in an effort to increase its market share. The new production line will cost $850,000 for manufacturing the parts and an additional $280,000 is needed for installation. The equipment falls into the MACRS 3-yr class, and would be sold after four years for $350,000. The equipment line will generate additional annual revenues of $600,000, and will have additional annual operating expenses of...
Read Book Company is the manufacturer of exercise machines and is considering producing a new line of equipment in an effort to increase its market share. The new production line will cost $850,000 for manufacturing the parts and an additional $280,000 is needed for installation. The equipment falls into the MACRS 3-yr class, and would be sold after four years for $350,000. The equipment line will generate additional annual revenues of $600,000, and will have additional annual operating expenses of...
Read Book Company is the manufacturer of exercise machines and is considering producing a new line of equipment in an effort to increase its market share. The new production line will cost $850,000 for manufacturing the parts and an additional $280,000 is needed for installation. The equipment falls into the MACRS 3-yr class, and would be sold after four years for $350,000. The equipment line will generate additional annual revenues of $600,000, and will have additional annual operating expenses of...
2. Read Book Company is the manufacturer of exercise machines and is considering producing a new line of equipment in an effort to increase its market share. The new production line will cost $850,000 for manufacturing the parts and an additional $280,000 is needed for installation. The equipment falls into the MACRS 3-yr class, and would be sold after four years for $350,000. The equipment line will generate additional annual revenues of $600,000, and will have additional annual operating expenses...
1. A firm is considering replacing the existing industrial air conditioning unit. They will pick one of two units. The first, the AC360, costs $26,081.00 to install, $5,081.00 to operate per year for 7 years at which time it will be sold for $7,075.00. The second, RayCool 8, costs $41,244.00 to install, $2,161.00 to operate per year for 5 years at which time it will be sold for $9,015.00. The firm’s cost of capital is 6.92%. What is the equivalent...
Matty's Place is considering the installation of a new computer system that will cut annual operating costs by $12,000. The system will cost $42,000 to purchase and install. This system is expected to have a life of 5 years and will be depreciated to zero using straight-line depreciation. Ignore bonus depreciation. What is the amount of the earnings before interest and taxes for each year of this project if the tax rate is 21 percent? Multiple Choice −$20,400 $5,400 $3,600...
You are considering a new project that requires $300,000 investment in a machine, including installation and shipping cost. The life of the machine is three years, and it depreciates via 3-year MACRS methods (33.33%, 44.45%, 14.81%, and 7.41%). If you operate this project, the annual sales of the firm increases by $250,000 a year, and the annual operating expense increased by $100,000. The firm has a marginal tax rate of 34%. In order to start the project, the firm has...
At the beginning of the year, Oakmont Company bought three used machines from American Manufacturing, Inc. The machines immediately were overhauled, were installed, and started operating. Because the machines were different, each was recorded separately in the accounts. Machine $ 20,600 800 Machine B $11,100 Amount paid for asset Installation costs Renovation costs prior to use Repairs after production began Machine C $10,800 200 600 480 900 700 1.900 600 420 By the end of the first year, each machine...