Company A is trying to determine whether to replace an existing asset. The propo

Question

Company A is trying to determine whether to replace an existing asset. The proposed asset has a purchase price of $50,000 and has installation costs of $3,000. The asset will be depreciated over its five year life using the simplified straight-line method. The new asset is expected to increase sales by $17,000 and non-depreciation expenses by $2,000 annually over the life of the asset. Due to the increase in sales, the firm expects an increase in working capital of $1,500, and the firm expects to be able to sell the asset for $6,000 at the end of its life. The existing asset was originally purchased three years ago for $25,000, has a remaining life of 5 years, and is being the asset depreciated using the simplified straight-line method. The expected salvage value at the end of the asset's life is $5,000; however, the current sale price of the existing asset is $20,000, and it's current book value is $15,625. Company A is in the 34% marginal tax bracket and has a required rate of return of 12%. Please show your calculations.

a. What is the initial cost of the project?

b. What are the free cash flows generated by this project each other?

c. What is the terminal cash flow?

d. Calculate the value of this project. Should you replace the existing asset?

Explanation / Answer

Company A All Amounts in $ a. Initial Cost of the Project = $ 50,000 + $ 3,000 + $ 1,500 = $ 54,500 b. Free Cash Flows generated by the project each year Increase in Sales 17000 Increase in Expenses 2000 Income before Taxes 15000 Tax Impact @ 34% 5100 Free Cash Flow per year 9900 c. Terminal Cash Flow = Salvage Value of equipment = $ 6,000 d. With the information given, the Net Present Value of the new project works out to -$ 14,082.97 Since the Net Present Value of the project is negative, that is the reason why it should not be undertaken.

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.