You are considering a cost reduction project for your business. The project will

Question

You are considering a cost reduction project for your business. The project will require investment of $1,500,000 in new equipment as an addition to existing equipment. The equipment has shipping and handling charges of $15,000 and will be installed for use in your facility at a cost of $100,000. The change will require an increase in inventory of $50,000 and notes payable will increase by $25,000. The equipment falls into the 3-year MACRS class (rates of 33%, 45%, 15%, and 7% in years 1-4, respectively). You expect to operate the new equipment for five years and then shut down operations. The salvage value of the equipment at time five is expected to be $250,000. The equipment change is not expected to lead to sales increases but will reduce annual operational costs by $450,000 in year 1 subsequent years savings increasing by 3%. Your business has a 40% tax rate and your WACC is 11%. Determine the time period five cash flow.

Explanation / Answer

Statement showing cash flows Particulars Time PVF Amoount PV Cash outflows 0            1.0000      (1,615,000.00)      (1,615,000.00) Increase in WC(50,000-25,000) 1-Jan            1.0000            (25,000.00)            (25,000.00) PV of Cash Outflows      (1,640,000.00) PV of Tax Savings on Depreciation 1-4            528,633.00 PV of Savings in Operational Costs 1-5        1,053,092.00 Salvage Value 5            0.5935            250,000.00            148,362.83 Working Capital 5            0.5935              25,000.00              14,836.28 PV of Cash Inflows        1,744,924.12 NPV            104,924.12 Year1 Year2 Year3 Year4 Year5 Reduction in operational exp    450,000.00    463,500.00            477,405.00            491,727.15    506,478.96 Tax Rate@40%    180,000.00    185,400.00            190,962.00            196,690.86    202,591.59 Savings in operational cost(Net of tax)    270,000.00    278,100.00            286,443.00            295,036.29    303,887.38 PVF                 0.90                 0.81                         0.73                         0.66                 0.59 PV of Savings in Operational Costs    243,243.24    225,712.20            209,444.65            194,349.54    180,342.37 Depreciation    532,950.00    726,750.00            242,250.00            113,050.00 Tax Rate@40% on depreciation    213,180.00    290,700.00              96,900.00              45,220.00 PVF                 0.90                 0.81                         0.73                         0.66 PV of Tax Savings on Depreciation    192,054.05    235,938.64              70,852.44              29,787.81

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