Chapter 13 In-Class Case J & J, Inc. is considering the purchase and installatio
ID: 2588769 • Letter: C
Question
Chapter 13 In-Class Case J & J, Inc. is considering the purchase and installation of new manufacturing equipment to replace its old equipment. The following information is available to use in evaluating this investment Add 300O0 Cost of the new equipment including sales tax would be $3,000,000. a. b. c, d. e. There would be an additional cost of $600,000 to set up and test the new equipment. J & J would plan to use the equipment for 8 years using straight-line depreciation. At the end of 8 years, J & J estimates the equipment could be sold for $30,000. Working capital investment of $750,000 is required. This amount would be released at the end of 8 years. The new equipment will make the manufacturing process more efficient, and management estimates the equipment will generate an annual cost savings of $800,000. A maintenance cost of $200,000 will be required at the end of the 4th year. If the new manufacturing equipment is purchased, the current equipment, which costs $900,000 could be sold immediately for $450,000. Accumulated depreciation on the equipment is $500,000. J & J's cost of capital is 10%. f. g. h. J & J's corporate tax rate is 35% J & J invest in the new equipment? 1. Based on the information provided above, should If J & J planned to use the equipment for 10 years instead of 8, the investment would generate an additional 2 years of cost savings. However, at the end of 10 years the equipment would have no resale value due to pending obsolescence. The working capital would still be released at the end of the investment. An additional maintenance cost of $200,000 would be required at the end of the 8th year. Other costs and rates would remain the same. How would your answer change if J & J planned to use the equipment for 10 years? 2. 30 00,00 ial TnvestmentExplanation / Answer
Question 1 Question 1 Working Note 1 Working Note 2 Working Note 3 Amount $ Terminal Cash Flows I . Initial Investment : Depreciation Value Salvage Value 30000 Cost Of New Equipment (3,600,000) Equipment Value 3,600,000 Working Capital 750000 Working Capital Required (750,000) - Salvage Value 30,000 780000 Sale of New Asset 450,000 3,570,000 (3,900,000) Life Time 8 years Dep. Per Year 446,250 Cash Flow Statement Amount $ Particulars Year 0 1 2 3 4 5 6 7 8 Coat Saving 800,000 800,000 800,000 800,000 800,000 800,000 800,000 800,000 Less Maintenance Cost (200,000) Depreciation (446,250) (446,250) (446,250) (446,250) (446,250) (446,250) (446,250) (446,250) 353,750 353,750 353,750 153,750 353,750 353,750 353,750 353,750 Less : Tax @ 35% 123,813 123,813 123,813 53,813 123,813 123,813 123,813 123,813 Profit After Tax 229,938 229,938 229,938 99,938 229,938 229,938 229,938 229,938 Add : Deprecation 446,250 446,250 446,250 446,250 446,250 446,250 446,250 446,250 Cash Flows 676,188 676,188 676,188 546,188 676,188 676,188 676,188 676,188 Initial Cash Out Flows (3,900,000) Terminal Cash Out Flows 780,000 Total Cash Flows (3,900,000) 676,188 676,188 676,188 546,188 676,188 676,188 676,188 1,456,188 PV Factor @ 10% 1.000 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 Dis Cash Flows (3,900,000) 614,654 558,531 507,817 373,046 419,912 381,370 346,884 680,040 Net Present Value (17,746) Hence NPV is negative , the new Equipment is not Recommedable Notes 1.Ignored the Tax on Profit on Sale of the Old Equipment Question 2 Question 2 Working Note 1 Working Note 2 Working Note 3 Amount $ Terminal Cash Flows I . Initial Investment : Depreciation Value Salvage Value 0 Cost Of New Equipment (3,600,000) Equipment Value 3,600,000 Working Capital 750000 Working Capital Required (750,000) - Salvage Value - 750000 Sale of New Asset 450,000 3,600,000 (3,900,000) Life Time 10 years Dep. Per Year 360,000 Cash Flow Statement Amount $ Particulars Year 0 1 2 3 4 5 6 7 8 9 10 Coat Saving 800,000 800,000 800,000 800,000 800,000 800,000 800,000 800,000 800,000 800,000 Less Maintenance Cost (200,000) (200,000) Depreciation (360,000) (360,000) (360,000) (360,000) (360,000) (360,000) (360,000) (360,000) (360,000) (360,000) 440,000 440,000 440,000 240,000 440,000 440,000 440,000 240,000 440,000 440,000 Less : Tax @ 35% 154,000 154,000 154,000 84,000 154,000 154,000 154,000 84,000 154,000 154,000 Profit After Tax 286,000 286,000 286,000 156,000 286,000 286,000 286,000 156,000 286,000 286,000 Add : Deprecation 360,000 360,000 360,000 360,000 360,000 360,000 360,000 360,000 360,000 360,000 Cash Flows 646,000 646,000 646,000 516,000 646,000 646,000 646,000 516,000 646,000 646,000 Initial Cash Out Flows (3,900,000) Terminal Cash Out Flows 750,000 Total Cash Flows (3,900,000) 646,000 646,000 646,000 516,000 646,000 646,000 646,000 516,000 646,000 1,396,000 PV Factor @ 10% 1.000 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.385 Dis Cash Flows (3,900,000) 587,214 533,596 485,146 352,428 401,166 364,344 331,398 240,972 273,904 537,460 Net Present Value 207,628 Hence NPV is Positive, the new Equipment is Recommedable Notes 1.Ignored the Tax on Profit on Sale of the Old Equipment
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