Ace Manufacturing is analyzing an investment opportunity that will altow the fir
ID: 2536530 • Letter: A
Question
Ace Manufacturing is analyzing an investment opportunity that will altow the firm to reproduce and distribute computer software and documentation. The equipment will cost $4,500,000 with 10-year useful life. The ship The firm is depreciating the equipment using straight line depreciation method to zero salvage value and expects to be able to sell the equipment for $700,000 at the end of its useful life. Ace Manufacturing expects to spend $50,000 to train its employees to use the equipment, and to invest $100,000 in the net working capital needed to support the project. If adopted, the project is expected to increase the firm's revenues by $2,000,000 per year and its costs by $600,000 per ping and installation of the equipment is expected to cost $500,000 year over the life of the project. Ace Manufacturing is taxed at a 40% marginal rate. a. Compute the net investment in the project. b. Compute the net cash flow per year c. Compute the terminal cash flow.Explanation / Answer
(a) Net Investment in the project :-
Equipment Cost
4500000
Shipping & Installation
500000
Training of Employees
50000
Net Working Capital
100000
Net Investment in the project
5150000
(b) Net Cash Flow per year :-
Increase revenue per year
2000000
(-) Cost increase per year
600000
Net Cash flow before tax
1400000
(-) Tax @ 40%
560000
Net Cash Flow per year before Depreciation Tax shield
840000
(+) Depreciation Tax shield (working Note)
200000
Net Cash Flow per year
1040000
Working Note :- Deprecition Tax Shield:-
Equipment Cost = 4500000 + 500000 = 5000000
Depreciation using SLM with no salvage = 5000000/10 = 500000
Depreciation Tax Shield = Depreciation * Tax Rate
= 500000 * 40% = 200000
(c) Terminal Cash Flow :-
Sell of Equipment at the end of useful life
700000
(-) Tax @ 40%
280000
Cash proceeds after Tax (A)
420000
Working Capital (B)
100000
Terminal Cash Flow (A+B)
520000
Equipment Cost
4500000
Shipping & Installation
500000
Training of Employees
50000
Net Working Capital
100000
Net Investment in the project
5150000