The Balas Manufacturing Company is considering buying an overhead pulley system.
ID: 2784695 • Letter: T
Question
The Balas Manufacturing Company is considering buying an overhead pulley system. The new system has a purchase price of $150,000, an estimated useful life and MACRS class life of five years, and an estimated salvage value of $10,000. The system is expected to enable the company to economize on electric power usage, labor, and repair costs, as well as to reduce the number of defective products made. A total annual savings of $95,000 will be realized if the new pulley system is installed. The company is in the 35% marginal tax bracket. The initial investment will be financed with 40% equity and 60% debt. The before-tax debt interest rate, which combines both short-term and long-term financing, is 12% with the loan to be repaid in equal annual installments over the project life. (a) Determine the after-tax cash flows. (b) Evaluate this investment project by using an MARR of 20%. (c) Evaluate this investment project on the basis of the IRR criterionExplanation / Answer
cost of machine
150000
Year
cost of machine
MACRS rate
Annual depreciation
Year
annual saving
less annual depreciation
annual saving after depreciation
annual saving aftertaxes = annual saving after depreciation*(1- tax rate)
annual savings after tax before depreciation = annual saving after tax+depreciation
present value of cash inflow/(1+r)^n r = 20%
1
150000
20%
30000
0
-150000
-150000
2
150000
32%
48000
1
95000
30000
65000
42250
72250
60208.33
3
150000
19.20%
28800
2
95000
48000
47000
30550
78550
54548.61
4
150000
11.52%
17280
3
95000
28800
66200
43030
71830
41568.29
5
150000
11.52%
17280
4
95000
17280
77720
50518
67798
32695.79
5
95000
17280
77720
50518
76914
30910.01
Accumulatd depreciation
141360
NPV = sum of present value of cash flow
69931.04
Book value of machine
150000-141360
8640
Gain on disposal of machine
10000-8640
1360
after tax gain on disposal of machine
1360*(1-35%)
884
cost of machine
after tax scrap value
10000-884
9116
Year
annual savings after tax before depreciation = annual saving after tax+depreciation
0
-150000
1
72250
2
78550
3
71830
4
67798
5
76914
IRR= using IRR function in MS excel at 20% MARR
39.92%
A-
Year
-150000
1
72250
2
78550
3
71830
4
67798
5
76914
B-
NPV
69931.04
C-
IRR
39.92%
Machine should be purchased as both the NPV and IRR decisions are in favor of acceptance of offer
cash flow in Year 5
50518+17280+9116
76914
cost of machine
150000
Year
cost of machine
MACRS rate
Annual depreciation
Year
annual saving
less annual depreciation
annual saving after depreciation
annual saving aftertaxes = annual saving after depreciation*(1- tax rate)
annual savings after tax before depreciation = annual saving after tax+depreciation
present value of cash inflow/(1+r)^n r = 20%
1
150000
20%
30000
0
-150000
-150000
2
150000
32%
48000
1
95000
30000
65000
42250
72250
60208.33
3
150000
19.20%
28800
2
95000
48000
47000
30550
78550
54548.61
4
150000
11.52%
17280
3
95000
28800
66200
43030
71830
41568.29
5
150000
11.52%
17280
4
95000
17280
77720
50518
67798
32695.79
5
95000
17280
77720
50518
76914
30910.01
Accumulatd depreciation
141360
NPV = sum of present value of cash flow
69931.04
Book value of machine
150000-141360
8640
Gain on disposal of machine
10000-8640
1360
after tax gain on disposal of machine
1360*(1-35%)
884
cost of machine
after tax scrap value
10000-884
9116
Year
annual savings after tax before depreciation = annual saving after tax+depreciation
0
-150000
1
72250
2
78550
3
71830
4
67798
5
76914
IRR= using IRR function in MS excel at 20% MARR
39.92%
A-
Year
-150000
1
72250
2
78550
3
71830
4
67798
5
76914
B-
NPV
69931.04
C-
IRR
39.92%
Machine should be purchased as both the NPV and IRR decisions are in favor of acceptance of offer
cash flow in Year 5
50518+17280+9116
76914
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