Please show your work if you can so I can learn how to solve a problem like this
ID: 2419236 • Letter: P
Question
Please show your work if you can so I can learn how to solve a problem like this, Thank you!
33. Deriving cash flows for abandonment decision. The Tiny Treasures Company must decide whether to continue selling a line of children's shoes manufactured on a ma- chine that has no other purpose. The machine has a current book value of S12,000, and Tiny Treasures can sell it today for $8,000. Tiny Treasures depreciates the ma- chine on a straight-line basis for tax purposes assuming no salvage value and could continue to use it four more years. If Tiny Treasures keeps the machine in use, it can sell it at the end of four years for $800, although this will not affect the depreciation charge for the next four years. The variable cost of producing a pair of shoes on the machine is less than the cash received from customers by $15.000 per year. To produce and sell the children's shoes requires cash outlays of $10,000 per year for ad ministrative and overhead expenditures as well. Tiny Treasures Company pays taxes at a rate of 40 percent. The rate applies to any gain or loss on disposal of the machine as well as to other income. From its other activities, Tiny Treasures Company earns more income than any losses from the line of children's shoes or from disposal of the machine a. Prepare a schedule showing all the cash and cost flows that Tiny Treasures Com- pany needs to consider in order to decide whether to keep the machine. b. Should Tiny Treasures Company keep the machine if its cost of capital is 12 percent? c. Repeat part b. assuming a cost of capital of 20 percent.Explanation / Answer
Tiny Treasure Compnay a If the machine is kept, the PV of cash Flows will be Year 1 Year 2 Year 3 Year 4 Net Contribution 15,000 15,000 15,000 15,000 Less Fixed cost 10,000 10,000 10,000 10,000 Add Salvage 800 Depreciation expense 3,000 3,000 3,000 3,000 Income before tax 2,000 2,000 2,000 2,800 Tax @40% 800 800 800 1,120 Net Income After Tax 1,200 1,200 1,200 1,680 Add back depreciation 3,000 3,000 3,000 3,000 Total post tax cash flow 4,200 4,200 4,200 4,680 Discount factor @12% 0.8929 0.7972 0.7118 0.6355 PV of cash flows 3,750 3,348 2,989 2,974 Total of PV of Cash flows $ 13,062 So , If the m/c is disposed , the value today is $ 8,000 If the m/c is kept the PV of cash flows today= $ 13,061.92 b So it is better to keep the machine. c If cost of capital is 20% If the machine is kept, the PV of cash Flows will be Year 1 Year 2 Year 3 Year 4 Net Contribution 15,000 15,000 15,000 15,000 Less Fixed cost 10,000 10,000 10,000 10,000 Add Salvage 800 Depreciation expense 3,000 3,000 3,000 3,000 Income before tax 2,000 2,000 2,000 2,800 Tax @40% 800 800 800 1,120 Net Income After Tax 1,200 1,200 1,200 1,680 Add back depreciation 3,000 3,000 3,000 3,000 Total post tax cash flow 4,200 4,200 4,200 4,680 Discount factor @20% 0.8333 0.6944 0.5787 0.4823 PV of cash flows 3,500 2,917 2,431 2,257 Total of PV of Cash flows $ 11,104 So , If the m/c is disposed , the value today is $ 8,000 If the m/c is kept the PV of cash flows today= $ 11,104.17 So it is better to keep the machine.