Sugar Land Company is considering adding a new line to its product mix, and the

Question

Sugar Land Company is considering adding a new line to its product mix, and the capital budgeting analysis is being conducted by a MBA student. The production line would be set up in unused space (Market value of zero) in Sugar Land’ main plant. Total cost of the machine is $190,000. The machinery has an economic life of 4 years, and MACRS will be used for depreciation. The machine will have a salvage value of 30,000 after 4 years.

The new line will generate Sales of 1,300 units per year for 4 years and the variable cost per unit is $100 in the first year. Each unit can be sold for $200 in the first year. The sales price and variable cost are expected to increase by 3% per year due to inflation. Further, to handle the new line, the firm’s net working capital would have to increase by $30,000 at time zero (The NWC will be recouped in year 4). The firm’s tax rate is 40% and its weighted average cost of capital is 10%.

What are the annual depreciation expenses for years 1 through 4?

Year 1 Year 2 Year 3 Year 4 Depreciation

Explanation / Answer

Annual depn for the firm

Year Depn Rate Depn Book Value 0        1,90,000 1 33.33%              63,327        1,26,673 2 44.45%              84,455            42,218 3 14.81%              28,139            14,079 4 7.41%              14,079                     -  

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