Please help.... I need help with all parts of this question - a,b,c,d,e,f,g. I a
ID: 2777484 • Letter: P
Question
Please help.... I need help with all parts of this question - a,b,c,d,e,f,g. I am having lots of difficulty solving and understanding what the question is asking. May someone please explain it using a step-by-step process that is not so vague, yet easy to understand and comprehend. Please provide the answers for a,b,c,d,e,f,g - also include any formulas that were used. I want to understand this question fully so that it will help me on future exams. Thanks so much in advance....
NOTE***** for the first part, do I ADD or SUBTRACT 50,000 from the initial outlay? I was confused, it says CHARGED but is that an outflow or inflow?
Question:
General Engine Corp. (GEC) has just finished minor renovations on their office building at a cost of $150,000. GEC originally allocated only $100,000 for this renovation. A memo from accounting suggests that the $50,000 cost overrun should be charged to the next new project the company will implement.
As its next project, General Engine Corp. is considering the acquisition of a new machine that would replace one of their old machines in use. The new machine costs $0.9 million (t=0), and it can be sold at the end of its expected 4-year operating life for $300,000. The new machine takes up more space and GEC will need to move maintenance and cleaning supplies that used to be stored next to the machine to a small storage room that could otherwise be sublet for $25,000 a year (at t=1 to t=4). The old machine was bought 8 years ago for $800,000 and can be sold for $300,000 today or for $150,000 in 4 years. GEC paid $25,000 for a study which indicates that the new machine will reduce manufacturing costs by $220,000 annually. Moreover, net working capital will be reduced by $150,000 when the new machine is installed, and will increase again by $150,000 at the end of the machine’s operating life. Both machines belong to asset class 43 with a CCA rate of 30%. GEC’s marginal tax rate is 40%, and it uses a discount rate (required rate of return, RRR) of 14% to evaluate projects of this nature.
a) What is the initial cash outlay (the total cash flow at t=0)?
b) What is the first year’s cash flow (excluding the CCA Tax Shield)?
c) What is the last year’s cash flow (excluding the CCA Tax Shield)?
d) What is the year 3 CCA?
e) What is the PV CCA Tax Shield?
f) What is the NPV of the replacement project?
g) Should General Engine Corp. replace the old machine with the new one?
Explanation / Answer
a)Initial Cash outlay:
Cost of new machine
900000
proceeds from old machine
-300000
Reduction in working capital
-150000
Total initial cash outflow
450000
b)
Reduction in manufacturing cost
220000
cost of extra space
-25000
Net cost saving
195000
(-) taxes 40%
-78000
Cash flow year 1
117000
c)
Reduction in manufacturing cost
220000
cost of extra space
-25000
Net cost saving
195000
(-) taxes 40%
-78000
OCF ( without cca benefit)
117000
Increase in working capital
-150000
Salvage value
300000
taxes on salvage value 40%
-120000
Total cash flow
147000
d)
Year 1 CCA using half year rule = Cost of asset x CCA rate /2
= 900,000 x 30%/2
=135,000
CCA base for 2nd year = 900,000-135000 = 765,000
CCA for 2nd year = CCA base x CCA rate
= 765,000 x 30%
= 229,500
CCA base for 3nd year = 765,000- 229,500
=535,500
CCA for 3rd year = CCA base x CCA rate
= 535,500x 30%
= 160,650
Cost of new machine
900000
proceeds from old machine
-300000
Reduction in working capital
-150000
Total initial cash outflow
450000