Question

Part A. ABC Inc. is considering purchase of a new equipment that will produce a new...

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
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Homework Answers

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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