Can you pls answer q 2 thanks 1) A natural gas distribution company is evaluatin

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Can you pls answer q 2

thanks

1) A natural gas distribution company is evaluating the economic desirability of replacing or repairing existing gas mains, it is estimated that 100,000 Mcf of gas being lost per year and that this gas could be sold to corporate customers at $8.00 per Mcf. The cost of replacing the gas mains is estimated to be $4,000,000 at time zero. Replacement of the mains would effectively eliminate all as loss for the next 10 years. The cost of repairing the gas mains is estimated to be $1,600,000 which would reduce annual gas loss to 25,000 Mcf at year one (allocated to the end of the year), with gas loss increasing by a constant gradient of 6,000 Mcf per year in years following year one. Use net present value analysis for a 10-year evaluation life and 15.0% to determine from an economic viewpoint if the gas mains should be replaced, repaired, or left in the present condition

Explanation / Answer

Alternative 1 - two used machines and 1 used machine

Old Machines

Depreciation per year on each old machine = $60000 / 5 = $12000

Depreciation Tax shield = $12000 x 40% = $4800

Total depreciation each year for first two years = $12000 x 2 = $24000

Book value of each machine at the end of 2nd year = $60000 - $24000 = $36000

Tax shield on loss on sale on each machine = ($36000 - $20000) x 40% = $6400

New Machine

Depreciation per year = $350000 / 5 = $70000

Depreciation Tax shield each year = $70000 x 40% = $28000

Total depreciation each year for first two years = $70000 x 2 = $140000

Book value of each machine at the end of 2nd year = $350000 - $140000 = $210000

Tax shield on loss on sale on each machine = ($210000 - $170000) x 40% = $16000

(-)$163000

(Inflow)

Total Present Value of Cash Outflows = $375,198.55

Alternative 2 - One new machine

Depreciation per year = $300000 / 5 = $60000

Depreciation Tax shield per year = $60000 x 40% = $24000

Book value after 4 years = $300000 - $60000 x 4 = $60000

Tax on Profit on sale = ($75000 - $60000) x 40% = $6000

Salvage value net of tax = $75000 - $6000 = $69000

0.869565

Total Present Value of Cash Outflows = $331,862.88

So, Alternative 2 is better as it has less cost.

Present Value of Cash Outflows Particulars Year 0 Year 1 Year 2 Year 3 Year 4 Initial Cost of Machine $60000 x 2 = $120000 $350000 Operating Costs (net of tax) $60000 x 2 x (1 - 0.40) = $72000 $70000 x 2 x (1 - 0.40) = $84000 $80000 x (1 - 0.40) = $48000 $85000 x (1 - 0.40) = $51000 Less: Depreciation Tax shield $4800 x 2 = $9600 $4800 x 2 = $9600 $28000 $28000 Less: Salvage Value $20000 x 2 = $40000 $170000 Less: Tax shield on Loss $6400 x 2 = $12800 $16000 Total Cash Outflows $120000 $62400 $371600 $20000

(-)$163000

(Inflow)

PVF@ 15% 1 0.869565 0.756144 0.657516 0.571753 Present Value $120000 $54260.86 $280983.11 $13150.32 (-)$93195.74

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