Calculating initial cash flow Vastine Medical, Inc., is considering replacing its existing computer system, which was purchased 2 years ago at a cost of $319,000. The system can be sold today for $206,000. It is being depreciated using MACRS and a 5-year recovery period (see the tablecomputer system will cost $491,000 to purchase and install. Replacement of the computer system would not involve any change in net working capital. Assume a 21% tax rate on ordinary income and capital gains.a. Calculate the book value of the existing computer system.b. Calculate the after-tax proceeds of its sale for $206,000.c. Calculate the initial cash flow associated with the replacement project.a. The remaining book value is $(Round to the nearest dollar.)Data table(Click on the icon herein order to copy the contents of the data table below into a spreadsheet.)Rounded Depreciation Percentages by Recovery Year Using MACRS forFirst Four Property ClassesRecovery year110 years10%18%14%12%9%8%7%6%6%6%4%100%100%100%100%Totals*These percentages have been rounded to the nearest whole percent to simplify calculations whileretaining realism. To calculate the actual depreciation for tax purposes, be sure to apply the actualunrounded percentages or directly apply double-declining balance (200%) depreciation using the half-yearconvention.2345 000 g678910113 years33%45%15%7%Percentage by recovery year*5 years20%32%19%12%12%5%PrintDone7 years14%25%18%12%9%9%9%4%X). A new

Capital budgeting process starts with the estimation of cash flows.While estimating cash flows for a…

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Cornerstones of Cost Management (Cornerstones Series)

4th Edition

ISBN:9781305970663

Author:Don R. Hansen, Maryanne M. Mowen

Publisher:Don R. Hansen, Maryanne M. Mowen

Chapter19: Capital Investment

Section: Chapter Questions

Problem 2CE

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Friedman Company is considering installing a new IT system. The cost of the new system is estimated to be 2,250,000, but it would produce after-tax savings of 450,000 per year in labor costs. The estimated life of the new system is 10 years, with no salvage value expected. Intrigued by the possibility of saving 450,000 per year and having a more reliable information system, the president of Friedman has asked for an analysis of the projects economic viability. All capital projects are required to earn at least the firms cost of capital, which is 12 percent. Required: 1. Calculate the projects internal rate of return. Should the company acquire the new IT system? 2. Suppose that savings are less than claimed. Calculate the minimum annual cash savings that must be realized for the project to earn a rate equal to the firms cost of capital. Comment on the safety margin that exists, if any. 3. Suppose that the life of the IT system is overestimated by two years. Repeat Requirements 1 and 2 under this assumption. Comment on the usefulness of this information.
Gallant Sports s considering the purchase of a new rock-climbing facility. The company estimates that the construction will require an initial outlay of $350,000. Other cash flows are estimated as follows: Assuming the company limits its analysis to four years due to economic uncertainties, determine the net present value of the rock-climbing facility. Should the company develop the facility if the required rate of return is 6%?
Gina Ripley, president of Dearing Company, is considering the purchase of a computer-aided manufacturing system. The annual net cash benefits and savings associated with the system are described as follows: The system will cost 9,000,000 and last 10 years. The companys cost of capital is 12 percent. Required: 1. Calculate the payback period for the system. Assume that the company has a policy of only accepting projects with a payback of five years or less. Would the system be acquired? 2. Calculate the NPV and IRR for the project. Should the system be purchasedeven if it does not meet the payback criterion? 3. The project manager reviewed the projected cash flows and pointed out that two items had been missed. First, the system would have a salvage value, net of any tax effects, of 1,000,000 at the end of 10 years. Second, the increased quality and delivery performance would allow the company to increase its market share by 20 percent. This would produce an additional annual net benefit of 300,000. Recalculate the payback period, NPV, and IRR given this new information. (For the IRR computation, initially ignore salvage value.) Does the decision change? Suppose that the salvage value is only half what is projected. Does this make a difference in the outcome? Does salvage value have any real bearing on the companys decision?
Although the Chen Company’s milling machine is old, it is still in relatively good working order and would last for another 10 years. It is inefficient compared to modern standards, though, and so the company is considering replacing it. The new milling machine, at a cost of $110,000 delivered and installed, would also last for 10 years and would produce after-tax cash flows (labor savings and depreciation tax savings) of $19,000 per year. It would have zero salvage value at the end of its life. The project cost of capital is 10%, and its marginal tax rate is 25%. Should Chen buy the new machine?
The Ham and Egg Restaurant is considering an investment in a new oven that has a cost of $60,000, with annual net cash flows of $9,950 for 8 years. The required rate of return is 6%. Compute the net present value of this investment to determine whether or not you would recommend that Ham and Egg invest in this oven.
Each of the following scenarios is independent. All cash flows are after-tax cash flows. Required: 1. Patz Corporation is considering the purchase of a computer-aided manufacturing system. The cash benefits will be 800,000 per year. The system costs 4,000,000 and will last eight years. Compute the NPV assuming a discount rate of 10 percent. Should the company buy the new system? 2. Sterling Wetzel has just invested 270,000 in a restaurant specializing in German food. He expects to receive 43,470 per year for the next eight years. His cost of capital is 5.5 percent. Compute the internal rate of return. Did Sterling make a good decision?
Garnette Corp is considering the purchase of a new machine that will cost $342,000 and provide the following cash flows over the next five years: $99,000, $88,000, $92,000. $87,000, and $72,000. Calculate the IRR for this piece of equipment. For further instructions on internal rate of return in Excel. see Appendix C.
Vastine Medical, Inc., is considering replacing its existing computer system, which was purchased 2 years ago at a cost of $318,000. The system can be sold today for $203,000. It is being depreciated using MACRS and a 5-year recovery period (see the table). A new computer system will cost $506,000 to purchase and install. Replacement of the computer system would not involve any change in net working capital. Assume a 21% tax rate on ordinary income and capital gains. a. Calculate the book value of the existing computer system. b. Calculate the after-tax proceeds of its sale for $203,000. c. Calculate the initial cash flow associated with the replacement project. Rounded Depreciation Percentages by Recovery Year Using MACRS for First Four Property Classes Percentage by recovery year* Recovery year 3 years 5 years 7 years 10 years 1 33% 20% 14% 10% 2 45% 32% 25% 18% 3 15% 19% 18% 14% 4 7% 12% 12% 12% 5 12% 9% 9% 6 5% 9% 8% 7 9%…
Vastine Medical, Inc., is considering replacing its existing computer system, which was purchased 2 years ago at a cost of $322,000. The system can be sold today for $201,000. It is being depreciated using MACRS and a 5-year recovery period (see the table attached).A new computer system will cost $505,000 to purchase and install. Replacement of the computer system would not involve any change in net working capital. Assume a 21% tax rate on ordinary income and capital gains. a. Calculate the book value of the existing computer system. b. Calculate the after-tax proceeds of its sale for $201,000. c. Calculate the initial cash flow associated with the replacement project.
Terminal cash flow: Replacement decision Russell Industries is considering replacing a fully depreciated machine that has a remaining useful life of 10 years with a newer, more sophisticated machine. The new machine will cost $198,000 and will require $29,600 in installation costs. It will be depreciated under MACRS using a 5-year recovery period (see the table for the applicable depreciation percentages). A $27,000 increase in net working capital will be required to support the new machine. The firm's managers plan to evaluate the potential replacement over a 4-year period. They estimate that the old machine could be sold at the end of 4 years to net $13,500 before taxes; the new machine at the end of 4 years will be worth $74,000 before taxes. Calculate the terminal cash flow at the end of year 4 that is relevant to the proposed purchase of the new machine. The firm is subject to a 21% tax rate. The terminal cash flow for the replacement decision is shown below: (Round to the nearest…
Terminal cash flow: Replacement decision Russell Industries is considering replacing a fully depreciated machine that has a remaining useful life of 10 years with a newer, more sophisticated machine. The new machine will cost $207,000 and will require $29,200 in installation costs. It will be depreciated under MACRS using a 5-year recovery period (see the table for the applicable depreciation percentages). A $26,000 increase in net working capital will be required to support the new machine. The firm's managers plan to evaluate the potential replacement over a 4-year period. They estimate that the old machine could be sold at the end of 4 years to net $14,000 before taxes; the new machine at the end of 4 years will be worth $73,000 before taxes. Calculate the terminal cash flow at the end of year 4 that is relevant to the proposed purchase of the new machine. The firm is subject to a 21% tax rate. The terminal cash flow for the replacement decision is shown below: (Round to the nearest…
Using payback, ARR, and NPV with unequal cash flows Henderson Manufacturing, Inc, has a manufacturing machine that needs attention, The company is considering two options. Option 1 is to refurbish the current machine at a cost of $1,200,000. If refurbished, Henderson expects the machine to last another eight years and then have no residual value. Option 2 is to replace the machine at a cost of $4,600,000. A new machine would last 10 years and have no residual value. Henderson expects the following net cash inflows from the two options: Henderson uses straight-line depreciation and requires an annual return of 10%. Requirements Compute the payback, the ARR, the NPV, and the profitability index of these two options. Which option should Henderson choose? Why?

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