Question

VML Industries needs specialized manufacturing equipment for finished plastic products to operate over the next 5years.VML...

VML Industries needs specialized manufacturing equipment for finished plastic products to operate over the next 5years.VML industries can use a 60% bonus depreciation in year 0 combined with MACRS depreciation schedule for tax estimation on this equipment. Three brands offer the required equipment. (1) Brand 1’s purchase cost is $14K, with annual maintenance of $2.5K, and salvage value of $5K after 5 years. (2) Brand 2 sells the equipment at $18Kwith annual maintenance of $1K, and salvage value of $10K after 5 years. (3) Brand 3 sells the equipment at $12.5K with annual maintenance of $5K. VML predicts a $0 salvage value from Brand3’s equipment after 5 years, so Brand3 offers a 20% discount on the purchase price to VML (the discount does not apply to the annual maintenance).The after-tax MARR for VML Industries is 25%. The Federal tax rate is 21% and the State tax rate is 12.66%.

Question 1. Conduct an incremental IRR analysis on the after-tax cash flows of the three alternatives and answer: which brand would you recommend to VML?

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Answer #1
25% 0 1 2 3 4 5
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Total
Brand 1 Purchase cost -14
AMC -2.5 -2.5 -2.5 -2.5 -2.5
Salvage 5
NPV -14 -2 -1.6 -1.28 -1.024 0.8192 -19.0848
Brand 2 Purchase cost -18
AMC -1 -1 -1 -1 -1
Salvage 10
NPV -18 -0.8 -0.64 -0.512 -0.4096 2.94912 -17.4125
Brand 3 Purchase cost -10
AMC -5 -5 -5 -5 -5
Salvage 0
NPV -10 -4 -3.2 -2.56 -2.048 -1.6384 -23.4464

Based on the excel attached above -

For Brand 2 we have lowest NPV cost. So it is recommended to purchase the Brand 2.

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