Question

Part A. ABC Inc. is considering purchase of a new equipment that will produce a new range of spare parts to complement its existing line of products. The new equipment will cost $500,000. Sales are expected to be around $200,000 per year and variable costs at $60,000. At the end of five years, the equipment can be sold for $100,000. Using straight line depreciation, should they purchase this equipment. Assume the cost of capital is 12% and the tax rate is 30%. Why or why not?

A. No, NPV = - $38,588.65

B. Yes, NPV = #24,000.44

C. No, NPV = - $12,086.99

D. Yes, NPV = $1,131.23

Part B. ABC Inc. is now considering the purchase new equipment to improve their production rates. They are considering two competing offers. Offer A's equipment costs $400,000 and will help increase after-tax cash flows by $120,000 for six years. Offer B's equipment costs $700,00 and will help increase after-tax cash flows by 152,000 for 10 years. Which offer should they accept and why? Note the offers have unequal lives and assume a discount rate of 15%.

A. Choose B because EANPV= $12,523.56 |
||

B. Choose A because EANPV = $14,305.24 |
||

C. Choose A because EANPV = $54,127.92 |
||

D. Choose B because EANPV = $62,852.83 |

Answer #1

Part A | Annual OCF = ((200000-60000-(500000)/5))*0.70+(500000)/5 = | 128000.00 |

PV of OCF = 128000*(1.12^5-1)/(0.12*1.12^5) = | 461411.35 | |

PV of after tax residual value = 100000*0.70/1.12^5 = | 0.00 | |

Total PV of cash inflows | 461411.35 | |

Less: Initial cash flow | 500000.00 | |

NPV | -38588.65 | |

Answer: Option [A] No, NPV = - $38,588.65 | ||

Part B | EANPV A: | |

AW of equipment cost = 400000*0.15*1.15^6/(1.15^6-1) = | 105694.76 | |

Annual increase in after tax cash flows | 100000.00 | |

EANPV A | -5694.76 | |

EANPV B: | ||

AW of equipment cost = 700000*0.15*1.15^10/(1.15^10-1) = | 139476.44 | |

Annual increase in after tax cash flows | 152000.00 | |

EANPV A | 12523.56 | |

Answer: Option [A] Choose B because EANPV= $12,523.56 |

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