Save Question 23 (12 points) Partial credit is possible if you show your inputs.

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Save Question 23 (12 points) Partial credit is possible if you show your inputs. Will's Winery is considering replacing equipment in its winery near campus. The new equipment will cost $270. Shipping of the new equipment will cost $60 and installation of the equipment will be $50. The old equipment has been in service for three years and has a depreciable basis of $200. The building will need modifications costing $100, but these will be paid by the landlord. The modifications, new equipment, and old equipment are depreciated using the 5-year MACRS schedule. Will's Winery will operate the winery for four years and then expects to sell the winery to an investor. We think the winery will sell for $600 plus any working capital, whether or not we buy the new equipment. To operate the winery, Will's Winery will need an increase in Inventory of $27, an increase of Accounts Receivables of $14, and will have an increase in Accounts Payable of $19. Working capital will be recovered when we sell the winery. Annual sales will increase will increase from $2000 to $2500, if we install the new equipment. Our current Cost of Goods Sold (excluding overhead, depreciation, and lease payments) is 50% of annual sales, and will remain at at 50%. To operate the equipment, operators must be hired at an annual fixed cost of $45. Will's has an agreement for a 3-year 6% amortized Small Business Administration Loan to finance the new equipment. Our outside auditor is raising his annual fee from $20 per year to $25 per year. The firm's tax rate is 30%. The cost of capital is 13%. What are the total Initial Cash Flows in Year 0? What are the total Operating Cash Flows in Year 2? What are the total Terminal Cash Flows in Year 4? (I want only Terminal Cash Flows, not operating cash flows in year 4)

Explanation / Answer

Answer:

Working notes:

1) Operating cash flows for old machinery: sales - cogs- dep- auditors fees

a) for calculation of depreciation using MARCS 5 year table:

For old machine dep is as follows:

For calculation of dep we use formuale= Dt=Book value* % of table rate

For example for $200 we use =200*20% =40 for 1 st year

For the second year book value= 200-40= 160

For dep for second year =200*32%=64

2) for new machine similar process has undertaken :

a)Operating cash flows for old machinery: sales - cogs- dep- auditors fees - Interest cost on the loan of new machine

b) Dep schedule is :

3) for the incremental cash flows :

A) Incremental investment in 0 year=Net investment by new machine- Net investment by old machine

=402-0 = $402

b) Incremental cash flows of incremental year are = Incremental periodic cash flow of new machine- Incremental cash flow of old machine and then discounted at present value of 13%

(ends)

In $ 0 1 2 3 4 old equipment cash flows Intial investment 0 sales 2000 minucogs @ 50% of sales 1000 Minusdepreciation as per MARCS schedule 40 MinusAuditor fee 20 Periodic cash flow 940 New equipment Intial investment in new machinery Purchase of new machinery 380 New intial investment 402 New sales 2500 2500 2500 2500 Minuscogs 1250 1250 1250 1250 Minudeprecitaion 76 122 73 43.8 Minus Interest on loans 22.8 22.8 22.8 Minus Auditor fees 25 25 25 25 Periodic cashflow 1,126 1,081 1,129 1,181 Investment in working capital 22 Selling of old machinery 600 Incremental cashflows in 0 year 402 Incremnatal cash flow from 1 year to 3 years 186 1,081 1,129 1,181 Terminal cashflow 1,781 PV of incremental cash flow 164.7788 846.2683 782.62 724.4668 Terminal value cashflow in 4 th years 1092.458

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