Armanny, chief financial officer of Jeysifap Company, expects the firm’s net profits after taxes for the next 5 years to be as shown in the following table. YEAR NET PROFIT AFTER TAX 1 100,000 2 150,000 3 200,000 4 250,000 5 320,000 Armanny is beginning to develop the relevant cash flows needed to analyze whether to renew or replace Jeysifap’s only depreciable asset, a machine that originally cost $30,000, has a current book value of zero, and can now be sold for $20,000. (Note: Because the firm’s only depreciable asset is fully depreciated— its book value is zero—its expected net profits after taxes equal its operating cash inflows.) He estimates that at the end of 5 years, the existing machine can be sold to net $2,000 before taxes. Armanny plans to use the following information to develop the relevant cash flows for each of the alternatives. Alternative 1 Renew the existing machine at a total depreciable cost of $90,000. The renewed machine would have a 5-year usable life and would be depreciated under MACRS using a 5-year recovery period. Renewing the machine would result in the following projected revenues and expenses (excluding depreciation): YEAR REVENUE EXPENSES (EXCL. DEPRECIATION) 1 1,000,000 801,500 2 1,175,000 884,500 3 1,300,000 918,100 4 1,425,000 943,100 5 1,550,000 968,000 The renewed machine would result in an increased investment in net working capital of $15,000. At the end of 5 years, the machine could be sold to net $8,000 before taxes. Alternative 2 Replace the existing machine with a new machine that costs $100,000 and requires installation costs of $10,000. The new machine would have a 5-year usable life and would be depreciated under MACRS using a 5- year recovery period. The firm’s projected revenues and expenses (excluding depreciation), if it acquires the machine, would be as follows: YEAR REVENUE EXPENSES (EXCL. DEPRECIATION) 1 1,000,000 764,500 2 1,175,000 839,800 3 1,300,000 914,900 4 1,425,000 989,900 5 1,550,000 998,900 The new machine would result in an increased investment in net working capital of $22,000. At the end of 5 years, the new machine could be sold to net $25,000 before taxes. The firm is subject to a 40% tax on both ordinary income and capital gains. As noted, the company uses MACRS depreciation. (Appendix) Required: a. Calculate the initial investment associated with each of Jeysifap’s alternatives. b. Calculate the incremental operating cash inflows associated with each of Jeysifap’s alternatives. (Note: Be sure to consider the depreciation in year 6.) c. Calculate the terminal cash flow at the end of year 5 associated with each of Jeysifap’s alternatives. d. Use your findings in parts a, b, and c to depict on a time line the relevant cash flows associated with each of Jeysifap’s alternatives. e. Solely on the basis of your comparison of their relevant cash flows, which alternative appears to be better? Why?
CAPITAL BUDGETING
Armanny, chief financial officer of Jeysifap Company, expects the firm’s net profits after taxes for the next 5 years to be as shown in the following table.
| YEAR | NET PROFIT AFTER TAX |
| 1 | 100,000 |
| 2 | 150,000 |
| 3 | 200,000 |
| 4 | 250,000 |
| 5 | 320,000 |
Armanny is beginning to develop the relevant
cash flows needed to analyze whether to renew
or replace Jeysifap’s only
machine that originally cost $30,000, has a
current book value of zero, and can now be sold
for $20,000. (Note: Because the firm’s only
depreciable asset is fully depreciated— its book
value is zero—its expected net profits after taxes
equal its operating
that at the end of 5 years, the existing machine
can be sold to net $2,000 before taxes. Armanny plans to use the following information to
develop the relevant cash flows for each of the alternatives.
Alternative 1 Renew the existing machine at a total depreciable cost of $90,000. The
renewed machine would have a 5-year usable life and would be depreciated under
MACRS using a 5-year recovery period.
Renewing the machine would result in the following projected revenues and expenses
(excluding depreciation):
| YEAR | REVENUE | EXPENSES (EXCL. DEPRECIATION) |
| 1 | 1,000,000 | 801,500 |
| 2 | 1,175,000 | 884,500 |
| 3 | 1,300,000 | 918,100 |
| 4 | 1,425,000 | 943,100 |
| 5 | 1,550,000 | 968,000 |
The renewed machine would result in an
increased investment in net working capital of
$15,000. At the end of 5 years, the machine
could be sold to net $8,000 before taxes.
Alternative 2 Replace the existing machine with
a new machine that costs $100,000 and
requires installation costs of $10,000. The new
machine would have a 5-year usable life and
would be depreciated under MACRS using a 5- year recovery period. The firm’s projected
revenues and expenses (excluding depreciation), if it acquires the machine, would be as
follows:
| YEAR | REVENUE | EXPENSES (EXCL. DEPRECIATION) |
| 1 | 1,000,000 | 764,500 |
| 2 | 1,175,000 | 839,800 |
| 3 | 1,300,000 | 914,900 |
| 4 | 1,425,000 | 989,900 |
| 5 | 1,550,000 | 998,900 |
The new machine would result in an increased
investment in net working capital of $22,000. At
the end of 5 years, the new machine could be
sold to net $25,000 before taxes.
The firm is subject to a 40% tax on both ordinary
income and
company uses MACRS depreciation.
(Appendix)
Required:
a. Calculate the initial investment associated with each of Jeysifap’s alternatives.
b. Calculate the incremental operating cash inflows associated with each of Jeysifap’s
alternatives. (Note: Be sure to consider the depreciation in year 6.)
c. Calculate the terminal cash flow at the end of year 5 associated with each of Jeysifap’s
alternatives.
d. Use your findings in parts a, b, and c to depict on a time line the relevant cash flows
associated with each of Jeysifap’s alternatives.
e. Solely on the basis of your comparison of their relevant cash flows, which alternative
appears to be better? Why?
Trending now
This is a popular solution!
Step by step
Solved in 5 steps with 9 images
