EI plans to acquire equipment, with a 3-year MACRS life, at a cost of $65,000 an

Question

EI plans to acquire equipment, with a 3-year MACRS life, at a cost of $65,000 and extra $7,500 for delivery and installation. EI expects the new equipment will help in boost its revenue by $40,000 annually for next 4 years and the operating cost is expected to increase by $15,000 each year. At the end of 4 year, Anderson expects to sell the equipment for $15,000 (salvage value). The applicable depreciation rates are 33%, 45%,15% and 7%. The net working capital would increase by $12,000 initially, but would be recovered at the end of project's 4-year life. EI’s marginal tax rate is 35% and WACC is 11.5%.

Explanation / Answer

System B Time line 0 1 2 3 4 Cost of equipment -65000 Installation cost -7500 Total investment in new machine -72500 -Working capital -12000 =Initial Investment outlay -84500 Revenues- operating cost 25000 25000 25000 25000 MACR rate 33% 45% 15% 7% 0.00% -Depreciation = Cost of equipment* MACR Rate -23925 -32625 -10875 -5075 0 =Salvage book value = 1075 -7625 14125 19925 -taxes =(cost- depreciation)*(1-tax) 698.75 -4956.25 9181.25 12951.25 +Depreciation 23925 32625 10875 5075 =after tax operating cash flow 24623.75 27668.75 20056.25 18026.25 Proceeds from sale of assets =salvage value*(1 - tax rate) 9750 +reversal of net working capital 12000 Terminal year non operating cash flows 21750 Total Cash flow for the period -84500 24623.75 27668.75 20056.25 39776.25 Discount factor =(1+discount rate)^n 1 1.115 1.243225 1.386196 1.545608 WACC= 11.50% Discounted cash flows -84500 22084.08 22255.63 14468.55 25735.01 NPV= Sum of discounted cash flows 43.27182

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