Problem1 (25 points). Two machines are being evaluated for possible acquisition
ID: 2433221 • Letter: P
Question
Problem1 (25 points). Two machines are being evaluated for possible acquisition by the Mortensen Corporation. Information relating to the two machines is provided below MORTENSEN CORPORATION INFORMATION FOR ALTERNATIVE CAPITAL INVESTMENTS Machine 1 Machine 2 Purchase Price Estimated Life (in years) Estimated Salvage Value Annual Before Tax Cash Income: 600,000 S 1,000,000 0,000 S 80,000 170,000 250,000 195,000 300,000 250,000 150,000 Year 1 Year 2 Year 3 100,000 S 150,000 200,000 200,000 60,000 140,000 Year 5 Year 6 The company will depreciate the assets using a tax depreciation method called MACRS. This will involve multiplying the cost of the investment by the percentages provided below for the given year MACRS depreciationassumes no salvage value in the calculation. The machines will therefore have a book value of zero at the end of their lives when they are sold and this will result in a gain on the sale of the machines at the end of their lives in the amount of the salvage value, which will be taxable income at that time. Also, the salvage value should be ignored when calculating the average investment in the machine.Explanation / Answer
(1)
MORTENSEN CORPORATION
CAPITAL BUDGETING DATA (IN $)
MACHINE 1
CASH INCOME
(A)
DEPRECIATION
(B)
INCOME BEFORE TAXES
C =A-B
INCOME TAXES
25 % OF C = D
INCOME AFTER TAXES
E =C - D
CASH FLOW AFTER TAXES
G = E- F
PRESENT VALUE @ 10%
20000
MORTENSEN CORPORATION
CAPITAL BUDGETING DATA (IN $)
MACHINE 2
CASH INCOME
(A)
DEPRECIATION
(B)
INCOME BEFORE TAXES
C =A -B
INCOME TAXES
25%OF C = D
INCOME AFTER TAXES
E = C - D
DEPRECIATION
F =(E *% AS GIVEN ABOVE IN TABLE
CASH FLOW AFTER TAXES
G = E - F
(2)
CACULATION OF ACCOUNTING RATE OF RETURN AFTER TAXES (EACH MACHINE)
ACCOUNTING RATE OF RETURN = AVERAGE CASH FLOWS AFTER TAXES / AVERAGE INVESTMENT
MACHINE 1 = (80000+124500+159600+155760+124608+107016/6 //600000/2)*100
=(125247/300000)*100
=41.75%
MACHINE 2
=(197200+304400+225252+330579+275482+158142 /6 //1000000/2)*100
=(248509/500000)*100
=49.70%
(3)
CACULATION OF PAYBACK PERIOD AFTER TAX OF EACH MACHINE
MACHINE 1
= YEAR + INITIAL INVESTMENT - CUMULATIVE PRESENT VALUE OF AFTER TAX CASH FLOWS / NEXT YEAR PRESENT VALUE OF AFTER TAX CASH FLOWS
= 6 + (600000 - 539540 / 60357)
=6+1.00
=7yrs
MACHINE 2
=YEAR + INITIAL INVESTMENT - CUMULATIVE PRESENT VALUE OF AFTER TAX CASH FLOWS / NEXT YEAR PRESENT VALUE OF AFTER TAX CASH FLOWS
= 5 + (1000000 - 997162 / 89192 )
=5 + .03
= 5.03 Yrs
(4)
CALCULATION OF NET PRESENT VALUE AFTER TAX OF EACH MACHINE (IN $)
NET PRESENT VALUE = TOTAL PRESENT VALUE OF AFTER TAX CASH FLOWS - INITIAL INVESTMENT
BY REFERRING POINT (3) CALCULATION TABLE , WE HAVE
MACHINE 1 = (72720 + 102837 + 119860 + 106384 + 77382 + 60357 ) - 600000
=539540 - 600000
= (-) $60460
MACHINE 2
= (179255 + 251434 + 169164 + 225785 + 171074 + 89192) - 1000000
= 1086354 - 1000000
=$86354
(5)
DECISION REGARDING INVESTMENT IN MACHINE TO BE MADE
ON THE BASIS OF CALCULATION IN ABOVE POINTS WE CONCLUDE THAT INVESTMENT SHOULD BE MADE IN MACHINE 2 . REASON IS NPV OFMACHINE 2 IS POSITIVE AND ALSO PAYBACK PERIOD OF MACHINE 2 IS 5 Yrs (approx) SO, IT IS MORE DESIRABLE FROM MORTENSEN CORPORATION POINT OF VIEW.
YEARCASH INCOME
(A)
DEPRECIATION
(B)
INCOME BEFORE TAXES
C =A-B
INCOME TAXES
25 % OF C = D
INCOME AFTER TAXES
E =C - D
DEPRECIATION F =( E* % AS GIVEN ABOVE IN TABLE )CASH FLOW AFTER TAXES
G = E- F
PRESENT VALUE @ 10%
PRESENT VALUE OF AFTER TAX CASH FLOWS 1 100000 20000 8000020000
60000 20000 80000 .909 72720 2 150000 48000 102000 25500 76500 48000 124500 .826 102837 3 200000 38400 161600 40400 121200 38400 159600 .751 119860 4 200000 23040 176960 44240 132720 23040 155760 .683 106384 5 160000 18432 141568 35392 106176 18432 124608 .621 77382 6 140000 8064 131936 32984 98952 8064 107016 .564 60357Related Questions
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