Weighted Average Cost of Capital and Net Present Value Analysis Tate Company is

Question

Weighted Average Cost of Capital and Net Present Value Analysis Tate Company is considering a proposal to acquire new equipment for its manufacturing division. The equipment will cost $192,000, be useful for four years, and have a $12,000 salvage value. Tate expects annual savings in cash operating expenses (before taxes) of $68,000. For tax purposes, the annual depreciation deduction will be $64,000, $86,000, $28,000, and $14,000, respectively, for the four years (the salvage value is ignored on the tax return). The income tax rate is 40% Tate establishes a cutoff rate for a net present value analysis at the company's weighted average cost of capital plus 1 percentage point. Tate's capital is provided in the following proportions: debt, 60%; common stock, 2096; and retained earnings, 2096. The cost rates for these capital sources are debt, 1096; common stock, 12%; and retained earnings, 1396. a. Compute Tate's (1) weighted average cost of capital and (2) cutoff rate. Round answers to one decimal place. For example, 0.4567 45.7%. Weighted Average Cost of Capital Debt Common stock Retained earnings 2.6 % 11 96 (1) Weighted avg, cost of capital (2) Tate's cut off rate: b. Using Tates cutoff rate, compute the net present value of this capital expenditure proposal Round answers to the nearest whole number. Use rounded answers for subsequent calculations. Use a negative sign with net present value to indicate a negative amount. Otherwise do not use negative signs with your answers. After-Tax Cash Flow Analysis Amount Present Value

Explanation / Answer

Amount Annuity Factor Present Value After-tax cash expense savings $ 40,800.00 3.04 $1,24,032.00 Tax savings from depreciation Year 1 $ 25,600.00 0.89 $    22,784.00 Year 2 $ 34,400.00 0.80 $    27,520.00 Year 3 $ 11,200.00 0.71 $      7,952.00 Year 4 $    5,600.00 0.64 $      3,584.00 After-tax equipment sale proceeds $    7,200.00 0.64 $      4,608.00 Total present value of future cash flows $1,90,480.00 Investment required in equipment $1,92,000.00 Net positive (negative) present value $    (1,520.00)

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