Managerial Acc, In-Class Handout with Solutions

Acct BASIC CAPITAL BUDGETING Rockyford Company must replace some machinery that has zero book value but a current market value of $L,800.One possibilityis to investin new machinery costing $40,000.This ne\tr machinery would produce estimated annual pretax operating cash savingsof $12,500.Assumethe new machine J14orro will have a usefullife of four yearsand depreciationof $L0,000eachyear for *'4o1book and tax purposes.It will have no salvagevalue at the end of four years. *u ral'c. The investmentin this new machinery would require an additional $S,OOOi7;',-in investmentof working capital. '1zproposal, the old disposal of the investment If Rockyford accepts this machinery and the investmentin the new one will occur on December3L of this year. The cashflows from the investmentwill occur during the next four calendaryears. Rockyford is subject to a 40 percent income tax rate for all ordinary income and capital gains and has a L0 percent after-tax cost of capital. All operatingand tax cashflows are assumedto occur at year-end. Required-- Determine: L. The presentvalue of the after-tax cashflow arising from disposingof the o l d m a c h i n e r y(.t t o t - O 0 v ) = f l f o o( a 4 k ; * x ( , - v ' 1 " 1 ' " ) = - t i ] [ : 2. The present value of the after-tax cash flows for the next four .years -nttributableto the operatingcashsavings.ft>;roo x 6oL x \'11 $ M 3. I.he presentvalue of the tax shieldeffectof depreciationat the end of year 1. ooo= V\-) (f 4-o, x f oL *to o e'1 o7 C,r"') -- * # 4. Which one of the following is the proper treatment for the $31000working capitalrequired in the current year? a. It should be ignored in capital budgeting becauseit is not a capital investment. It is a sunk costthat needsno considerationin reAfudas part of the initial investmentwhen determining nt value. the net 0. tIT[-oUA be spreadover the machinery'sfour-year life as a cashoutflow in each of thq years. e. It should be included as part of the cost of the new machine and depreciated. (CMA Adapted) 1 /* c'l 7t i. t)v---/ ,/t '/ -z ra'Le-r 4"1. vu*e. tr*"ALe. '>l7l o I I I (r,"Q llSco lvr9eo lz.,.fae ( r-.") vo31 Joo o ,t= f i't"L x.tg3 6 / L, 'do X A"L 't-L (r^t- *t) F:t "1 t,2 lr tD t/mt \""o flrbYo 3.r1 -al L: IO L [*"C[' re .e C"st ,( G4, 2 CASH FLOW ANALYSIS AND NPV Lou Lewis,thepresidentof the LewisvilleCompany,hasaskedyou to give him an thecompanyowns. of thebestuseof a warehouse analysis tu,;fr;' ^^^;t< l=i*, Companyis currentlyleasingthe warehouseto anothercompanyfor er month on a year-to-yearbasis. r estimatedsalesvalueis $200,000.A commercialRealtor U.{fne warehouse's in the nearfuture.The , * / believesthatthepriceis likely to remainunchanged at $1,;00annually. Its is beingdepreciated ttl,u"F I UritAlngoriginallycost$60,000+1d s L Jery.c ove"t$oy ,s / f current net book value is $7,500. \ 6(o,6ro [ -(:ss'rx rfau/t; =+z,s* B'oL Va-A,,'t- ,({"'-,/. 1'/ convertln&thewarehouse into a c. LewisvilleCompanyis seriouslyconsidering nd will be factory outlet for furniture.The remodelingwill extremelymodestbecausethe major attractionwill bl rock- bottom prices.The iatedover the next fi usins the doubleremodelingwill be PV@ tLo met declininq-balance 6v,(r-"'€*I PV + 5 (*1vss*\a-, The inventory,cash,and receivables n and sustainthe factorv outletwould be $600,000.This total 1 S llv recoverab when- ever operations terminate. , \ e . Lou is fairly certainthe warehousewill be condemnedin 10 yearsto make room for anewhighway. The firm most likely would receive$200,000from the condemnation. Xrrgl t f. Estimatedannualoperatingdata,exclusiveof depreciation,are: Sales $900,000 Operationexpenses Jffi:.H; 6olo -[lgg,-f = v,t--,,svv Nonrecurringsalespromotion Qostsat thedee (*n^'aeJ.u,'{t6(.). 6 l-} -(oo,crsox 6 " % ) = 6 o , t ' r . of u f t of year 1 are expectedto sa^t u *-*, + @t ; r-., ,-". I r 6"L xvl='ry^-ift J J cosrs termination unn@fueadur. [50,000.x h. Nonrecurring The minimum annualrate of return desiredis 14 percent.The companyis in the 40 percenttax bracket. \__, ,tr.- 5t*""r tY""4 q L\\-=-Tt*W,*l 4t6, fwe's ' irt r'i\+ i ='6e'ow *uf n/* 6'% tl,a-gga'vet'"*tf 5. 'ir'T *J^*';J "n'/' au*Q'at' - -") 3 the bestuseof thewarehouse. to determine Company formbelowfor Lewisville theanalysis Complete PV Factor o PV INYEAR CASHFLOWS _..-.....--.--...---- = } f zto,orro lo 5E:ll wa$a,A.$/*.e*, a'Jt+t"' DDB De,Prec, =7 f ,/'t-dt"b on\h""L -\ 4 a4 e'l/ \& o 2c#) Bvx = DD9 To% a) 'a,x ,t . !' I :-.i.. 3V l' la o O T D \ I Gvf Pe,p"c. - ! S::L,&d g I Z 3 + 5 to",fltr *q nro i -j- ,i, : ul i o 5 'l "l O O CY) V O O O n O cr) V n ! c) O $ O O n E€€ (u29 ro V c) I O)c R$e o.i e6P _: I Fr p \il I vl o-I z - n o n O O O O V V N o) r.oc.r o N(of-O)r q\qqq ooooo EI tJ.l tal I e a=xg tr _Elb i O c\I @ (9 tO @ O O)c -S.=.o x.! ar6 gE q E 9 "dl t=#a 518 ol u) =l (s ah .f-, - cl r) _cs o :- CUE t o Eea Li lC)l -: q lnl o \9 -cio F'6 c\I o^ I INII v vt€Ell GI t 'anl | ,,1 | \rl IJ f(1 o) 6'E ci o X P6t Ia .=6 .EE d=s O 4d| O O) 8.hlRjl o) pt8ll c"tHE \too ! o) tE[ \) Ic o q- E Hl e G ot = -t ? >I t crc r,' vo OO OO o$ OOrCOCD V- 8:NcDNN G o n (o n 6V N .\' ol .L -c I-l c N Fgs E6F 8"rE 66o O (o r r= E>PI tvt (5L ,o ee E L3 8$s3h$ O_ O- cY)^@- 'r)- e.l @ @ LO cY) N o.l E n I !f.- orF = =\ cl (U co= fl-[ -l El [|"t .o oEh =.t o EoQ .if g.'l n O \f, LO 6'fr o b X* Q o =o Q.x ,-O 619 6.E: ? F.9= eETEH? 6o-E+ sEer$f o a'-LooS '!* Tj r,{ i{- fr ! I U, -C 6;c oo vI Ae: co o oE 5of Eoo F q b c.) o0 - H o ( /o)oo ( s - o o)'{- X g#c6o - ! P v) o ( u> .^! J r\ c = eE E>.?; H .t 3€E3 E '!-i;5- t?E 6 @- FiE aj *: di e.i S l-i c oN O o@ o 6 'a MACHINE REPLACEMENT WITH TAX CONSIDERATIONS -3'-ke'off,' developa special- A computerchip manufacturerspentffift" purposemolding machine.The machinehas bee_n for one r and will or this machine. At the beginning of manufacturing costs from disposalvalue at the end of gost$2,000,000, will reduceannual cash to $1,000,000,and will have zero Managementhas decidedto use the double-declining-balance depreciation\method for tax purposes if this h:3 machineis purchased. The old machine'ssalvagevalue is $300,000now and will be $50,000three yearsfrom now; however,no salvagevalueis provided in calculatingstraightline depreciationfor tax purposes. Required: Assumethat income tax rates are 45 percent. The minimum rate of return desired,after taxes,is 8 percent.Using the net presentvalue technique,show whetherthe firm shouldpurchasethe new machine. U- trL 7 Yt'* ?V rl Crst .i' t 17(n-o,i'gl) "Ft t6,*lT' Fz4'to*' v +5L :- -@) Sazw..r{n 9av, * +? t 4-?t - > ?ex 5e.//2f tl.- /sSs, 9 11'-46MachineReplacement (15 min) with traxConsiderations Valueof Costswiththe Original Present Equipment Presentvalueof tax savingson depreciation: + 4x0.45x2.577= $2,500,000 Presentvalueof operating costs: x (1 - 0.45)x2.577= $1,800,000 Presentvalueof salvagevalue: x (1 - 0.45)x0.794 = $50,000 Presentvalueof costswiththe originalequipment $724,781 <2,551,230> 21,835 <$l-SOaOU> Presentvalueof the costswiththe newmachine lnitialoutlay Present valueof taxsavingson depreciation: BeginningDepreciation Tax Tax Discount Present Year BookValue Expense Rate Saving Factor Value 1 $2,000,000 x 0.926 $ 555,600 $1,333,333x 0.45= $600,000 2 666,667 444,445x 0.45= 200,000x 0'.857 171,400 222,223 222,223x 0.45= 100,000 3 x 0.794 79,400 proceeds Cash fromsaleof the old machine 300,000 Taxsavingof losson disposal of the oldmachine - $300,000) ($1,875,000 x 0.45= 708,750 Presentvalueof operating costs x (1 - .45)x2.577= $1,000,000 Totalcostat presentvalue fromusingthe newmachine: Savings - $t ,656,200 = $148,414 $1,804,61a The totalcostof the new machine, including the purchasecostandthe operating costin eachof thethreeyears,is $148,414belowthetotalcostof withthe originalequipment. continuing purchaseof the new Financially good machineis a investment. Blocher,Chen,Lin: Cost Management lI-49 @TheMcGraw-Hill Companies,Inc.,2002 10 KYZ Manufacturing Company proiid"" vending machines for soft-drink mangfacturers.The companyhas been investigatinga new piece of machineryfor its productiondepartment.The old equipmenthasa remaininglife of ten yearsand the new equipment has a value of $391,200with a ten-year life. The expected additionalcashinflows are $75,000per year.What is the internalrate of return? 1. ,e 6,d) (o-) ffits 1C Trrf$ 15 1t 1f ?AnPc -<* 6Prt -:F 2. InvestmentA requiresa net investmentof $l ,435,00A.The requiredrate of return is 18% for the five-year annuity. What are the annualcashinflows if the net present value equals0? (rounded) 7 (,nd A;--cf i' tt8 i'i ? cF ec *c#=tryg 11 TheZZZ Corporationwantsto purchasea new machinefor its factory operationsat a costof $800,000.The investmentis expectedto generate$400,000in annualcash flows for a periodof five years.Therequiredrateof returnis 10%.Theold machine canbe soldfor $75,000.The machineis expectedto havezero valueat the end of the five-year period. What is the net presentvalue of the investment?Would the cornDanvwant to purchasethe new machine? Income taxes are not considered. v @) ^?t i4os (d l"A t ? It'a +e Itg6-+ 1{_ t17t,w >s Yes 12 4. The )OO( Corporationwants to purchasea new machinefor its factory operations at a cost of $800,000.The investmentis expectedto generate$400,000in annual cash flows for a period of five years. The required rate of return rs l0%. The old machinecan be sold for $75,000.The machineis expectedto havezero value at the end of the five-yearperiod.Income taxes are considered. The new machine is depreciatedunder the straight-line method and the tax rate is25Yo. What is the net presentvalue ofthe investment? Would the companywant to purchasethe new machine? What is the approximateIRR of the investment? (owl io t"h t 6*\ y.vdL x,1( * ,7{ * Jt- ll' I + 2(o (o (o ,fr1v 1{ --tfl-- 56rflwo A/+ v5 .Fm '&- -@2.)l> n*7 r, 8oo. ,_)ftl,ol' *$7of|'ft 13 b#H I \g"r +aU v t7Y ==.?Z:,! ,W.rW7Ig,ttA ffi f, t +?s t,r.g,l 5. w sa -*f tg,g A.6 H-L "-:k The DDB Corporation*ants to purchaseai6flmfChine for its factory operationsat a costof $800,000.The investmentis expectedto generate$400,000in annualcash flows for a period of five years.The requiredrate of return is lUYo.The old machine qan be sold for $75,000.The machineis expectedto havezero value at the end of . The new machine is the five-year period. method and the tax rate is depreciatedunder th 25"/". What is the net presentvalue ofthe investment? Would the companywantlo purchasethe new machine? the investment? What is the apprgxi 8vx"(*a * AVx to?' G*I 7s ftov +oo (qo ?o, Fn x -1s ,1s 1t .1f .7s oe +Se 3e 3e ]ao ]eo +w r28,{ + >I,.6 +>(,.6 € vgo F -+ 3w x"921 v2a,q ./' ,7{l 3z( -6 ,693 4 tt6.1ldl(+ ,ft.19>E + t??,Vtl s v flfrt}rL Ye5 TEF- ? 7 @ 14