A firm is considering renewing its equipment to meet increased demand for its pr
ID: 2363311 • Letter: A
Question
A firm is considering renewing its equipment to meet increased demand for its product. The cost of equipment modifications is $1.86 million plus $119,000 in installation costs. The firm will depreciate the equipment modifications under MACRS, using a 5-year recovery period. (see table below for the applicable depreciation percentages) Additional sales revenue from the renewal should amount to $1.19 million per year, and additional operating expenses and other costs (excluding depreciation and interest) will amount to 36% of the additional sales. The firm is subject to a tax rate of 40%. Percentage by recovery year Recovery year 5 years 1 20% 2 32% 3 19% 4 12% 5 12% 6 5% A. What incremental earnings before depreciation,interest, and taxes will result from the renewal? B. What incremental net operating profits after taxes will result from the renewal? C. What incremental operating cash inflows will result from the renewal?Explanation / Answer
ANSWER:
A. Revenue $1,200,000
Operating ($480,000)
(1200000 X 40%)
expense
EBDIT $720,000
B Total cost of equipment
Cost of Equipment $1,900,000
Add: Installation cost $100,000
total Cost of equipment $2,000,000
Depreciation expense $2000000 X 20% (double-declining)
(MACRS) for 1 year
= $400,000
1st year
Revenue $1,200,000
Operating ($480,000)
expense
Depreciation ($400,000)
Net operating
profit before $320,000
Tax
Tax 40% ($128,000)
($320000 X40%)
Net operating $192,000
profit after
Tax
C Free cash flow = Net profit + Depreciation- Capital expenditure
Free cash flow = $192000 + $400000 - $100000
OR Free cash flow = $492,000
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