Assume a situation in which a company has an existing asset, A, that has a current net book value (original cost less accumulated depreciation to date) of $300,000. This asset has a useful life of 3 additional years. Its estimated disposal (sales) value both today and at the end of 3 years is zero. Asset B, which would replace A, could be purchased today for $600,000. If purchased, B would generate annual (cash) operating cost savings (pretax) of $280,000 for each year of its 3-year useful life. In determining depreciation deductions for tax purposes, assume the straight-line method and zero salvage value for both assets. The company is subject to a combined (federal, state, and local) income tax of 40%, both for operating income and gains/losses related to the sale of assets. Other than the initial outlay for asset B, assume that all cash flows (and related tax payments) occur at the end of the year. Assume a weighted-average cost of capital of 10%. (Use Table 1 and Table 2.) (Do not round intermediate calculations.) Required: 1. Determine the relevant (i.e., differential) cash flows (after-tax) at each of the following three points related to this asset-replacement decision: (1) project initiation (i.e., time 0), (2) project operation (i.e., end of years 1, 2, and 3), and (3) project disposal/termination (i.e., end of year 3). 2. What is the estimated net present value of the decision to replace asset A (the existing asset) with asset B? Use the built-in NPV function in Excel. (Round your final answer to nearest whole dollar amount.) 3. What is the weighted-average cost of capital (WACC) that would make the company indifferent between keeping or replacing asset A? Use the Goal Seek option in Excel to answer this question. (Round your final answer to 2 decimal places.)
Depreciation Methods
The word "depreciation" is defined as an accounting method wherein the cost of tangible assets is spread over its useful life and it usually denotes how much of the assets value has been used up. The depreciation is usually considered as an operating expense. The main reason behind depreciation includes wear and tear of the assets, obsolescence etc.
Depreciation Accounting
In terms of accounting, with the passage of time the value of a fixed asset (like machinery, plants, furniture etc.) goes down over a specific period of time is known as depreciation. Now, the question comes in your mind, why the value of the fixed asset reduces over time.
Assume a situation in which a company has an existing asset, A, that has a current net book value (original cost less
Required:
1. Determine the relevant (i.e., differential) cash flows (after-tax) at each of the following three points related to this asset-replacement decision: (1) project initiation (i.e., time 0), (2) project operation (i.e., end of years 1, 2, and 3), and (3) project disposal/termination (i.e., end of year 3).
2. What is the estimated
3. What is the weighted-average cost of capital (WACC) that would make the company indifferent between keeping or replacing asset A? Use the Goal Seek option in Excel to answer this question. (Round your final answer to 2 decimal places.)
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