Part A. ABC Inc. is considering purchase of a new equipment that will produce a
ID: 2619467 • Letter: P
Question
Part A. ABC Inc. is considering purchase of a new equipment that will produce a new range of spare parts to complement its existing line of products. The new equipment will cost $500,000. Sales are expected to be around $200,000 per year and variable costs at $60,000. At the end of five years, the equipment can be sold for $100,000. Using straight line depreciation, should they purchase this equipment. Assume the cost of capital is 12% and the tax rate is 30%. Why or why not?
A. No, NPV = - $38,588.65
B. Yes, NPV = #24,000.44
C. No, NPV = - $12,086.99
D. Yes, NPV = $1,131.23
Part B. ABC Inc. is now considering the purchase new equipment to improve their production rates. They are considering two competing offers. Offer A's equipment costs $400,000 and will help increase after-tax cash flows by $120,000 for six years. Offer B's equipment costs $700,00 and will help increase after-tax cash flows by 152,000 for 10 years. Which offer should they accept and why? Note the offers have unequal lives and assume a discount rate of 15%.
A. Choose B because EANPV= $12,523.56
B. Choose A because EANPV = $14,305.24
C. Choose A because EANPV = $54,127.92
D. Choose B because EANPV = $62,852.83
A. Choose B because EANPV= $12,523.56
B. Choose A because EANPV = $14,305.24
C. Choose A because EANPV = $54,127.92
D. Choose B because EANPV = $62,852.83
Explanation / Answer
Part A Annual OCF = ((200000-60000-(500000)/5))*0.70+(500000)/5 = 128000.00 PV of OCF = 128000*(1.12^5-1)/(0.12*1.12^5) = 461411.35 PV of after tax residual value = 100000*0.70/1.12^5 = 0.00 Total PV of cash inflows 461411.35 Less: Initial cash flow 500000.00 NPV -38588.65 Answer: Option [A] No, NPV = - $38,588.65 Part B EANPV A: AW of equipment cost = 400000*0.15*1.15^6/(1.15^6-1) = 105694.76 Annual increase in after tax cash flows 100000.00 EANPV A -5694.76 EANPV B: AW of equipment cost = 700000*0.15*1.15^10/(1.15^10-1) = 139476.44 Annual increase in after tax cash flows 152000.00 EANPV A 12523.56 Answer: Option [A] Choose B because EANPV= $12,523.56