In considering an investment, the cost of new equipment is $2 million each and installation is $1.3 million each. The company is considering purchasing 5 units. This purchase will allow service to 300 more customers, but the additional services are only needed 40 days a year. The cost to run extra equipment will be $500 per day for each of the 200 days that the business is open each year. Customer tickets are $55 a day and added expenses to each customer will be $5. Economic life of new equipment is 20 years.
How to find the before tax NPV with required rate of return of 14%, and also after tax NPV with required rate of return of 8% when income tax rate is 40% and MACRS recovery period is 10 years.
Will the investments be profitable?© BrainMass Inc. brainmass.com October 24, 2018, 6:34 pm ad1c9bdddf
In Excel, the solution is laid out and calculated with explanation.
1. The capital budgeting department is contemplating whether to purchase a piece of equipment. The new piece of equipment costs $900,000. The equipment currently being used b the firm would be replaced by the new and would e sold for $100,000 which is the firms book value fort he asset. The estimated useful life of the new equipment is 3 years. The firm's capital gain tax rate is 20% and their ordinary tax rate is 40%. The new equipment is not expected to have a salvage value at the end of its useful life and the firm uses straight-line depreciation.
Year Without the new equipment With the new equipment
1 $500,000 $1,200,000
2 $700,000 $1,500,000
3 $900,000 $1,900,000
Year Without the new equipment With the new Equipment
1 $200,000 $500,000
2 $250,000 $550,000
3 $300,000 $600,000
Calculate the net investment, net cash flows, the net present value and the Internal Rate of Return on this project assuming an 8% cost of capital. (25 points)
1. Net Investment = $900,000 - 100,000*(1-40%) = $840,000
2. Net Cash Flows = Increase in cash flow*(1-t) + Increase in depreciation * t
Year Cash flow:
1 (1,200, -500,)*(1-40%) + (500, - 200,)*40% = 540,000
2 (1,500,-700,)*(1-40%) + (550, - 250,)*40% = 600,000
3 (1,900, -900,)*(1-40%) + (600, - 300,)*40% = 720,000
3. Net Present Value
The present of each cash flow is computed by:
PVi = CF / (1+r)^i
Where r = 8% and i is the number of years.
By a financial calculator, NPV = $745,963
4. Internal Rate of Return
By a financial calculator, IRR = 38.9%, which is higher than the cost of capital.
2.How would your answer to number 1 change if the existing asset that is being replaced was sold at $125,000. The assets original purchase price was $500,000 Remember the assets book value is $100,000. Assume all other facts are the same as in question number 2. ( make sure to calculate the net investment, net cash flows, net present value and IRR.)
Net Investment $_______________________________
Net Cash Flows $_______________________________
Net Present Value $_______________________________
Internal Rate of Return ___________________________%