FIN 331 – Homework – Capital Budgeting and Cash Flows Your firm is considering r

Question

FIN 331 – Homework – Capital Budgeting and Cash Flows Your firm is considering replacing a machine that originally cost $275,000 with a new machine costing $340,000. It will also cost $10,000 to install the new machine. The new machine has a much higher output and would increase sales by $110,000 each year. The new machine is also more efficient and will save $10,000 in operating costs annually. The new machine would take more floor space causing the firm to cease leasing a portion of it plant at $15,000 per year. The new machine will be depreciated under the three year MACRS class over a three-year project life. The new equipment will increase inventories by $8,000 and increase accounts payable by $15,000. The old equipment being replaced can be sold today for $50,000. The old machine was being depreciated using MACRS three-year life and had been used for three years. Other important information for your decision is as follows. The firm’s tax rate is 30%. The firm’s cost of capital is 8%. At the end of the three-year use of the new equipment, the equipment can be sold for $70,000. What are the project’s cash flows? A. The total cost of the new asset = $275,000+$10,000=$285,000. B. Change in Net Working Capital = $15,000-$8000 = $7,000 C. Net Cash flow from sale of old asset initial investment = 50,000 + ($-30,750).30= $40,775 D. Change in revenues =$110,000 - $15,000 = $95,000 E. Change in operating costs = decrease cost by $10,000 per year F. Year Decreciation Expense (new) 1 $350,000 x .33=$115,500 2 $350,000 x .45=$157,500 3 $350,000 x .15=$52,500 4 $350,000 x .07=$24,500 Old depreciation Year Deprciation 1 $275,000 x .33=$90,750 2 $275,000 x .45=$123,750 3 $275,000 x .15=$41,250 4 $275,000 x .07=$19,250 (115,500 – 41,250) = 74,250 year 1 (157,500 – 19,250) = 138,248 year 2 (41,250) = year 3 chenge in tax year 1=9225 year 2=9974 year 3=19,125

Explanation / Answer

Note 1: Increase in revenue (110000)+ Savings in cost (10000)- Loss of Leasing Revenue (15000) = $105000

Initial Outflow: Cost of Machinery $3,40,000 Installation $10,000 Revenue/Expense Changes: Increase in Sales $1,10,000 Savings in Operating Costs $10,000 Loss of Leasing Revenue -$15,000 Sale of Machinery (after Year 3) $70,000 Changes in Working Capital Increase in Inventories -$8,000 Increase in Payables $15,000 Depreciation Schedule Year 0 Year 1 Year 2 Year 3 Year 4 Depreciation Rate 33% 44% 15% 7% Depreciation Amount 116655 155575 51835 25935 (350000*33%)- same for all years Income Statement: Year 1 Year 2 Year 3 Year 4 Revenue $1,05,000 $1,05,000 $1,05,000 $70,000 Depreciation 116655 155575 51835 25935 Profit Before Tax (Revenue- Depreciation) -$11,655 -$50,575 $53,165 $44,065 Tax (PBT*Tax Rate) -$3,496.50 $0.00 $15,949.50 $13,219.50 Profit after Tax (PBT-Tax) $0 $0 $37,216 $30,846

Note 1: Increase in revenue (110000)+ Savings in cost (10000)- Loss of Leasing Revenue (15000) = $105000

Cash Flow Year 0 Year 1 Year 2 Year 3 Year 4 Initial Outflow -350000 Profit after Tax $0.00 $0.00 $37,215.50 $30,845.50 Depreciation 116655 155575 51835 25935 Increase in Inventories -$8,000 -$8,000 -$8,000 Increase in Payables $15,000 $15,000 $15,000 Cash Flow -350000 123655 162575 96050.5 56780.5

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