Please answer all parts. It has a,b and c. show steps A firm is considering the

Question

Please answer all parts. It has a,b and c. show steps

A firm is considering the purchase of equipment which will cost $3 million. This equipment will last for 10 years, at the end of which it can be sold for $800,000. The CCA rate for this asset class is 30%, and the firm expects to have other assets in this asset class at the end of year 10. This equipment is expected to increase before-tax operating cash flows by $750,000 per year. However, in order to put the equipment to use, an additional $150,000 will need to be invested in net working capital initially (i.e., at t=0). The required rate of return is 16% and the firm’s marginal tax rate is 35%.
                                                                                                    

a) Should the firm purchase this equipment?

b) Suppose that to arrive at the before-tax operating cash flows in part (a), we have used the following estimates:

Fixed costs = $120,000

Variable costs = 60% of sales

What is the Net Present Value of the new equipment if, in the best-case scenario, we estimate that fixed costs could be lower by 20% and sales revenues could be higher by 25%?

c) Given the information in (a), and assuming that fixed costs are $120,000 and variables costs are 60% of sales, what is the sales level at which Net Present Value equals zero? (In other words, what is the financial break-even sales level?)

Explanation / Answer

Answer:-

Investment = 300000 + 150000

= 3150000

Year = 10 years

Scrap value = 800000

Profit befor Depreciation = 750000 per annuam

Depreciation = 30%

Cash Inflow = Profit befor Depreciation(PBD) - Depreciation

= Profit befor tax - tax(35%)

= Profit after tax + Depreciation + Scrap valve

Net Present Value (NPV) = Present Value - Investment

= 3127517 - 3150000

= -22483

NOT BUY THIS EQUIPMENT [ NPV is negative, so firm not purchase this Equipment ]

Year CIF = {[(PBD-Dep.) -Tax] + Dep.} PVIF at 16% Present Value 1 750000 - (3000000*30%) = -150000 - (150000*35%) = -202500+900000 = 697500 .862 601245 2 750000 - 630000= 120000 - 42000 = 78000 - 630000 = 708000 .743 526044 3 750000 - 441000= 309000 - 108150= 200850 + 441000 = 641850 .641 411426 4 750000 - 308700= 441300 - 154455= 286845 + 308700 = 595545 .552 328741 5 750000 - 216090= 533910 - 186869= 347041 + 216090 = 563131 .476 268050 6 750000 - 151263= 598737 - 209558= 389179 + 151263 = 540442 .410 221581 7 750000 - 105884= 644116 - 225441= 418675 + 105884 = 524559 .354 185694 8 750000 - 74119= 675881 - 236558= 439323 + 74119 = 513442 .305 156600 9 750000 - 51883= 698117 - 244341= 453776 + 51883 = 505659 .263 132988 10 750000 - 36318= 713682 - 249789= 463893 + 36318 = 500211 + 800000 = 1300211 .227 295148 TOTAL 3127517

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