Time value of money
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SAC is considering the purchase of new equipment to manufacture specialty spark plugs.
The new equipment would allow the firm to manufacture 100,000 additional spark plugs per year and is expected to have a useful life of 5 years and to have no salvage value at that time.
SAC will depreciate the equipment using the straight-line method. Specialty spark plugs are selling for an average price of $20 and are expected to cost $8 to manufacture with the new equipment. Indirect costs are expected to remain the same.
The equipment will cost $3,000,000 to purchase and install. SAC's tax rate is 34%.
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The solution goes into a great amount of detail related to the time value questions being asked. The solution is very easy to follow along and can be easily understood by anyone with a basic understanding of the concepts. The solution answers all the question(s) being asked in a succinct way. Overall, an excellent response.
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First we need to determine the incremental operational cash flow using this new equipment.
Incremental revenue = 100,000*$20=$2,000,000
Incremental cost = 100,000*$8=$800,000
Indirect costs remain the same.
Thus, incremental profits = Incremental revenue - Incremental cost = 2,000,000-800,000 = $1,200,000
Depreciation Expense = 3,000,000/5 = ...
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