An industrial engineer proposed the purchase of scanning equipment for the compa
ID: 1124878 • Letter: A
Question
An industrial engineer proposed the purchase of scanning equipment for the company's warehouse and weave rooms. The engineer felt that the purchase would provide a better system of locating cartons in the warehouse by recording the locations of the cartons and storing the data in the computer. The estimated investment, annual operating and maintenance costs, and expected annual savings are as follows:
Cost of equipment and installation: $65,500.
Project life: 6 years.
Expected salvage value: $3,000.
Investment in working capital (fully recoverable at the end of the project life): $10,000.
Expected annual savings on labor and materials: $55,800.
Expected annual expenses: $8,120.
Depreciation method: declining balance, depreciation rate 35%.
The rm's marginal tax rate is 35%.
(a) Determine the net after-tax cash ows over the project life.
(b) Compute the IRR for this investment.
(c) At MARR=18% is the project acceptable?
Book Vaue
Income Statement End of Year Revenue Expenses Labor Material Overhead Depreciation Taxable income Income Tax Net Income Cash Flow Statement Operating Activities Net Income Depreciation Investment Activities Milling Machine Salvage Value Gain Tax Working Captial Financing Activities Borrowed funds Repayment of principle Net Cash Flow PW = IRR =Explanation / Answer
Answer:
Calculation of net after tax cash flows over the project life
Year
0
1
2
3
4
5
6
Cost of equipment & Installation
-$65,500.00
Investment in working capital
-$10,000.00
Savings on Labour & material cost
$55,800.00
$55,800.00
$55,800.00
$55,800.00
$55,800.00
$55,800.00
Tax @ 35% on savings on Labour & Material cost
-$19,530.00
-$19,530.00
-$19,530.00
-$19,530.00
-$19,530.00
-$19,530.00
Expenses
-$8,120.00
-$8,120.00
-$8,120.00
-$8,120.00
-$8,120.00
-$8,120.00
Tax saving @ 35% on Expenses
$2,842.00
$2,842.00
$2,842.00
$2,842.00
$2,842.00
$2,842.00
Tax saving @ 35% on Depreciation
$4,585.00
$7,336.00
$4,401.60
$2,640.96
$2,640.96
$1,320.48
Recovery of working capital
$10,000.00
Salvage Value
$3,000.00
Tax @ 35% on salvage value
-$1,050.00
Net After Tax Cash flows
-$75,500.00
$35,577.00
$38,328.00
$35,393.60
$33,632.96
$33,632.96
$44,262.48
Answer a
Calculation of IRR of the project
Year
Cash flows
0
-$75,500.00
1
$35,577.00
2
$38,328.00
3
$35,393.60
4
$33,632.96
5
$33,632.96
6
$44,262.48
IRR of the investment =
42.31%
Answer b
The project is acceptable under MARR 18% as the IRR of the project is greater than minimum acceptable rate of return.
Working
Calculation of depreciation on Equipment using 5 Year MACRS
Year
Capitalised Cost
Depreciation rate
Depreciation
Tax saving @ 35%
1
$65,500.00
20%
$13,100.00
$4,585.00
2
$65,500.00
32%
$20,960.00
$7,336.00
3
$65,500.00
19.20%
$12,576.00
$4,401.60
4
$65,500.00
11.52%
$7,545.60
$2,640.96
5
$65,500.00
11.52%
$7,545.60
$2,640.96
6
$65,500.00
5.76%
$3,772.80
$1,320.48
Calculation of net after tax cash flows over the project life
Year
0
1
2
3
4
5
6
Cost of equipment & Installation
-$65,500.00
Investment in working capital
-$10,000.00
Savings on Labour & material cost
$55,800.00
$55,800.00
$55,800.00
$55,800.00
$55,800.00
$55,800.00
Tax @ 35% on savings on Labour & Material cost
-$19,530.00
-$19,530.00
-$19,530.00
-$19,530.00
-$19,530.00
-$19,530.00
Expenses
-$8,120.00
-$8,120.00
-$8,120.00
-$8,120.00
-$8,120.00
-$8,120.00
Tax saving @ 35% on Expenses
$2,842.00
$2,842.00
$2,842.00
$2,842.00
$2,842.00
$2,842.00
Tax saving @ 35% on Depreciation
$4,585.00
$7,336.00
$4,401.60
$2,640.96
$2,640.96
$1,320.48
Recovery of working capital
$10,000.00
Salvage Value
$3,000.00
Tax @ 35% on salvage value
-$1,050.00
Net After Tax Cash flows
-$75,500.00
$35,577.00
$38,328.00
$35,393.60
$33,632.96
$33,632.96
$44,262.48
Answer a
Calculation of IRR of the project
Year
Cash flows
0
-$75,500.00
1
$35,577.00
2
$38,328.00
3
$35,393.60
4
$33,632.96
5
$33,632.96
6
$44,262.48
IRR of the investment =
42.31%
Answer b
The project is acceptable under MARR 18% as the IRR of the project is greater than minimum acceptable rate of return.
Working
Calculation of depreciation on Equipment using 5 Year MACRS
Year
Capitalised Cost
Depreciation rate
Depreciation
Tax saving @ 35%
1
$65,500.00
20%
$13,100.00
$4,585.00
2
$65,500.00
32%
$20,960.00
$7,336.00
3
$65,500.00
19.20%
$12,576.00
$4,401.60
4
$65,500.00
11.52%
$7,545.60
$2,640.96
5
$65,500.00
11.52%
$7,545.60
$2,640.96
6
$65,500.00
5.76%
$3,772.80
$1,320.48