Please analyze both designs and choose the best one. A firm must decide between

Question

Please analyze both designs and choose the best one.

A firm must decide between two silicon layer chip designs from Intel. Their effective income tax rate is 40%, and MACRS depreciation is used. If the desired after-tax return on investment is 10% per year, which design should be chosen? Capital investment MV at end of useful life Annual revenues less expenses MACRS property class Useful life Design A $1,110,000 $1,090,000 $260,000 5 years years Design B $1,940,000 $1,060,000 $450,000 5 years years Click the icon to view the GDS Recovery Rates (rk) for the 5-year property class Click the icon to view the interest and annuity table for discrete compounding when the MARR is 10% per year

Explanation / Answer

We can use the NPV criteria to decide which design to choose. Design having higher NPV will be selected. Calculation of NPV of Design A Year 0 1 2 3 4 5 6 7 NPV Capital Investment -$1,110,000.00 Net revenue $260,000.00 $260,000.00 $260,000.00 $260,000.00 $260,000.00 $260,000.00 $260,000.00 Tax on net revenue @ 40% -$104,000.00 -$104,000.00 -$104,000.00 -$104,000.00 -$104,000.00 -$104,000.00 -$104,000.00 MV at the end of useful life $1,090,000.00 Tax on MV @ 40% -$436,000.00 Depreciation tax shield $88,800.00 $142,080.00 $85,248.00 $51,148.80 $51,148.80 $25,574.40 $0.00 Net Cash flow -$1,110,000.00 $244,800.00 $298,080.00 $241,248.00 $207,148.80 $207,148.80 $181,574.40 $810,000.00 x Discount factor @ 10% 1 0.9091 0.8264 0.7513 0.683 0.6209 0.5645 0.5132 Present Values -$1,110,000.00 $222,547.68 $246,333.31 $181,249.62 $141,482.63 $128,618.69 $102,498.75 $415,692.00 $328,422.68 Calculation of depreciation tax shield of Design A Year Capital Investment GDS recovery rates Depreciation Depreciation Tax shield @ 40% 1 $1,110,000.00 0.2 $222,000.00 $88,800.00 2 $1,110,000.00 0.32 $355,200.00 $142,080.00 3 $1,110,000.00 0.192 $213,120.00 $85,248.00 4 $1,110,000.00 0.1152 $127,872.00 $51,148.80 5 $1,110,000.00 0.1152 $127,872.00 $51,148.80 6 $1,110,000.00 0.0576 $63,936.00 $25,574.40 Calculation of NPV of Design B Year 0 1 2 3 4 5 6 NPV Capital Investment -$1,940,000.00 Net revenue $450,000.00 $450,000.00 $450,000.00 $450,000.00 $450,000.00 $450,000.00 Tax on net revenue @ 40% -$180,000.00 -$180,000.00 -$180,000.00 -$180,000.00 -$180,000.00 -$180,000.00 MV at the end of useful life $1,060,000.00 Tax on MV @ 40% -$424,000.00 Depreciation tax shield $155,200.00 $248,320.00 $148,992.00 $89,395.20 $89,395.20 $44,697.60 Net Cash flow -$1,940,000.00 $425,200.00 $518,320.00 $418,992.00 $359,395.20 $359,395.20 $950,697.60 x Discount factor @ 10% 1 0.9091 0.8264 0.7513 0.683 0.6209 0.5645 Present Values -$1,940,000.00 $386,549.32 $428,339.65 $314,788.69 $245,466.92 $223,148.48 $536,668.80 $194,961.85 Calculation of depreciation tax shield of Design B Year Capital Investment GDS recovery rates Depreciation Depreciation Tax shield @ 40% 1 $1,940,000.00 0.2 $388,000.00 $155,200.00 2 $1,940,000.00 0.32 $620,800.00 $248,320.00 3 $1,940,000.00 0.192 $372,480.00 $148,992.00 4 $1,940,000.00 0.1152 $223,488.00 $89,395.20 5 $1,940,000.00 0.1152 $223,488.00 $89,395.20 6 $1,940,000.00 0.0576 $111,744.00 $44,697.60 As the NPV of Design A is higher compared to NPV of Design B , a firm must choose Design A.

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