Pintail Products, Inc. Pintail Products, Inc. (PPI) is negotiating for the purch
ID: 2716359 • Letter: P
Question
Pintail Products, Inc.
Pintail Products, Inc. (PPI) is negotiating for the purchase of a new piece of equipment for its current operations. PPI has a bid which specifies that the equipment could be purchased for $80,000.
Other information about the project includes the following: The new equipment will replace existing equipment that has a current market (i.e., resale) value of $20,000. If the new equipment is purchased, the old equipment will be sold. The old equipment was purchased for $40,000 and is being depreciated on a straight-line basis over ten years. It is expected to last another eight years and to have no resale value at the end of eight years. It is currently five years old.
The new equipment is expected to have a positive effect on revenue. Revenues are expected to increase by $2,000 the first year, by $3,000 the second year, and by $4,000 the third year and following years for the duration of the project. Additionally, before-tax operating costs will be reduced by $11,000 per year for eight years. The revenues and cost savings will occur at year-end.
The increased sales will give rise to an aggregate increase in accounts receivable, inventory, and cash, equal in total to 25% of the increase in sales. The increase in current asset occurs at the beginning of each year. Additionally, trade credit (i.e., accounts payable) will increase by an amount equal to 10% of the increase in sales. The increase in accounts payable occurs at the beginning of each year. The initial increase in receivables, inventory, cash, and payables will occur at time 0 (i.e., they are needed to get the project started). This investment in working capital will be recovered at the end of the project’s life.
The new equipment will be depreciated to zero using straight-line depreciation over eight years. PPI expects to discontinue this project, and sell the equipment of $5,000 at the end of eight years. The gain from the proceeds of the sale is subject to the ordinary income tax rate of 35%. The after-tax nominal cost of capital for this project is 12% per year.
What is the NPV of replacing the old machine with the new one?
Explanation / Answer
Ans
Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Initial Cost -80,000.00 Resale Value Less tax on Capital gain 20000-((20000-(40000-(40000/10)*5)*35%) 20,000.00 Initial Outlay (1) -60,000.00 (Increase)Recoveryin Working Capital (2) -300.00 -450.00 -600.00 -600.00 -600.00 -600.00 -600.00 -600.00 4,350.00 Increase in Revenue 2,000.00 3,000.00 4,000.00 4,000.00 4,000.00 4,000.00 4,000.00 4,000.00 Add reduction Operating Cost 11,000.00 11,000.00 11,000.00 11,000.00 11,000.00 11,000.00 11,000.00 11,000.00 Increase in Operating cash flow before tax and Dep A 13,000.00 14,000.00 15,000.00 15,000.00 15,000.00 15,000.00 15,000.00 15,000.00 Increase in Operating cash flow After tax A*.65 8,450.00 9,100.00 9,750.00 9,750.00 9,750.00 9,750.00 9,750.00 9,750.00 Tax Shield on Incremental Depreciation(Depreciation of new- Depreciation of Old)*.35 2,100.00 2,100.00 2,100.00 2,100.00 3,500.00 3,500.00 3,500.00 3,500.00 Net Operating Cash inflow After Tax and Dep tax Shield (3) 10,550.00 11,200.00 11,850.00 11,850.00 13,250.00 13,250.00 13,250.00 13,250.00 Salvage Value less tax (4) 3,250.00 5000*0.65 Net Cash Inflow(outflow) -60,300.00 10,100.00 10,600.00 11,250.00 11,250.00 12,650.00 12,650.00 12,650.00 20,850.00 DF @ 12% 1 0.8928571 0.7971939 0.7117802 0.6355181 0.5674269 0.5066311 0.4523492 0.4038832 Dicounted cash flow -60,300.00 9,017.86 8,450.26 8,007.53 7,149.58 7,177.95 6,408.88 5,722.22 8,420.97 NPV 55.23