An auto repair shop is considering purchasing automated paint-spraying equipment

Question

An auto repair shop is considering purchasing automated paint-spraying equipment. The company estimates that the equipment will last five years. Each year, it will save the company S4,000 in paint wasted in the current manual spraying operation. It will also reduce labour costs by S40,000. It is estimated that the machine will incur maintenance costs of $2,000 per year The machine costs $140,000 (installed with all peripherals), and is expected to have a residual value of S10,000 at the end of five years. Top management needs you to determine the internal rate of return for this equipment in order to decide whether to purchase it, and how to fund i You may assume that the company income tax rate is 30%, and for this analysis is paid the year in which it is incurred. You may also assume that for tax purposes, the equipment is depreciated at a rate of 20% of its capital cost. Your answer should be within ± 0.5% of the correct value Clearly show your working

Explanation / Answer

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A B C D E F Year 0 1 2 3 4 5 1 New machine cost savings -140000 2 Cost savings in paint 4000 4000 4000 4000 4000 3 Labour cost savings 40000 40000 40000 40000 40000 4 Maintenance cost 2000 2000 2000 2000 2000 5 Depreciation = 20%* Capital Cost 28000 28000 28000 28000 28000 6 Net EBIT= Cost savings in paint+ Labour cost savings - Maintenenace cost - Depreciation 14000 14000 14000 14000 14000 7 Tax =EBIT*Tax rate 4200 4200 4200 4200 4200 8 Net Income =EBIT-tax 9800 9800 9800 9800 9800 9 Depreciation 28000 28000 28000 28000 28000 10 After tax salvage value=
residual value* ( 1-tax rate) 7000 11 Free Cash Flow=net income+depreciation+after tax residual value -140000 37800 37800 37800 37800 44800 IRR 12.07% IRR(A11:F11)

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