18. Paul Tribble will acquire new equipment for CNU that falls under the five-ye

Question

18. Paul Tribble will acquire new equipment for CNU that falls under the five-year MACRS category. The. cost is $500,000. If the equipment is purchased, the following earnings before depreciation and taxes be generated for the next six years.

Year 1

152000

Year 2

185000

Year 3

102000

Year 4

83000

Year 5

67000

Year 6

54000

CNU is in a 20% tax bracket and has a 14 percent cost of capital. Should Mr. Tribble purchase the equipment? Use the net present value method (12 points).

Year 1

152000

Year 2

185000

Year 3

102000

Year 4

83000

Year 5

67000

Year 6

54000

Explanation / Answer

Depreciation = Investment x MACRS(%)

Investment = 500,000

Net Income = EBIT x (1 - tax rate)

Tax rate = 20%

Cash Flows = Net Income + Depreciation

NPV can be calculated using NPV function in excel or calculator or equation using 14% cost of capital

NPV = NPV(14%, 141600...48960) - 500000 = -66,986.49

As NPV < 0, Mr. Tribble should not purchase the equipment.

EBITDA MACRS% Depreciation EBIT Net Income Cash Flows Year 0 0 0 0 0 0 -500000 Year 1 152000 20% 100000 52000 41600 141600 Year 2 185000 32% 160000 25000 20000 180000 Year 3 102000 19.20% 96000 6000 4800 100800 Year 4 83000 11.52% 57600 25400 20320 77920 Year 5 67000 11.52% 57600 9400 7520 65120 Year 6 54000 5.76% 28800 25200 20160 48960 NPV -$66,986.49

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