1. The Flunk Co. Inc. asked you evaluate an option to manufacture a new product.
ID: 2494166 • Letter: 1
Question
1. The Flunk Co. Inc. asked you evaluate an option to manufacture a new product. Flunk expects the demand for the product to exist for ten years and the equipment to process the product to require $350,000 to purchase and install. The capital equipment will have a resale value of $70,000 at the end of the ten years. The new expanded program will require the purchase of a two acre lot for $75,000 and the erection of a butler building for $200,000 (assume the year begins in January and they purchase the land and building in January and sell it in December of the last year). They have made a deal with the present landowner to purchase the land and building back for the book value when the production run is completed so there will be no capital gains on the building. The land and building will have to be purchased out of cash since no lender can be found for it. Flunk has found that a 9-year, 12% loan for 70% of the cost of the capital equipment can be obtained to finance the purchase of the equipment. Flunk plans to use a 7-year MACRS depreciation system for income tax calculations. The investment tax credit rate is 11% on the equipment, the capital gains tax rate is 21%, the income tax rate is 46%, and Flunk uses an after-tax MARR of 12%. If the product will generate a gross income of $125,000 per year before depreciation etc: do the analysis and evaluate the decision. 2. If Flunk could not find outside funds for the capital investment and had to put the total $350,000 up front under the same conditions as in problem 1, is this a good option? 3. If Flunk could lease the machine under the same conditions as Problem 1 except the lease payments would be $55,000 for the equipment with the purchase of the building and land staying the same. PREFERABLY IN EXCEL PLS!! :)
Explanation / Answer
1. Calculating the cashflow on account of purchase of Machine
Purchase Price = $350,000
Loan Amount = 70% * Purchase Price = $245,000 (since the question is silent about interest and repayment, assumed interest paid is annual and the principal is paid back at the end of 9 years)
Therefore, cashflow on account of loan of machinery will be:
Year 0 - 70% of asset loan received i.e. $245,000
Year 1 to Year 8 - Interest payment of 12% = $29,400
Year 9 - Interest + Principal = $274,400
2. Depreciation and capital gains on sale of assets
Machine:
Total Depreciation at the end of 10 years = $350,000
Book Value at the end of 10 years = 0
Profit on Sale of machine = $70,000 - $0 = $70,000
Tax on profit on sale of machine = 21% * $70,000 = $14,700
Net cashflow on sale of asset = $70,000 - $14,700 = $55,300
Building:
Total Depreciation at the end of 10 years = $51,074
Book Value at the end of 10 years = $200,000 - $51,074
Profit on Sale of machine = 0
Tax on profit on sale of machine = 0
Net cashflow on sale of asset = $148,926
Land:
No depreciation is charged on land
Book value at the end of 10 years = $75,000
Profit on Sale of machine = 0
Tax on profit on sale of machine = 0
Net cashflow on sale of asset = $75,000
Total Cashflow = $55,300 + $148,926 + $75,000 = $279,226
Total Capital Gain Tax = $14,700
3. Calculating operating income and operating cash-flow (Capital changes accounted separately)
4. Final NPV calculation
Year RateEquipment Depreciation on Equipment Rate
Building (Non-residential Property Rates used) Depreciation on Building Total Depreciation 1 14.29% 50015 2.461% 4922 54937 2 24.49% 85715 2.564% 5128 90843 3 17.49% 61215 2.564% 5128 66343 4 12.49% 43715 2.564% 5128 48843 5 8.93% 31255 2.564% 5128 36383 6 8.92% 31220 2.564% 5128 36348 7 8.93% 31255 2.564% 5128 36383 8 4.46% 15610 2.564% 5128 20738 9 0.00% 0 2.564% 5128 5128 10 0.00% 0 2.564% 5128 5128 350000 51074 401074
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.