Rockyford Company must replace some machinery that has zero book value and a current market value of $1,600. One possibility is to invest in new machinery costing $41,000. This new machinery would produce estimated annual pretax cash operating savings of $16,400. Assume the new machine will have a useful life of four years and depreciation of $10,250 each year for book and tax purposes. It will have no salvage value at the end of four years. The investment in this new machinery would require an additional $2,300 investment of net working capital. (Assume that when the old machine was purchased the incremental net working capital required at the time was $0.)
If Rockyford accepts this investment proposal, the disposal of the old machinery and the investment in the new one will occur on December 31 of this year. The cash flows from the investment will occur during the next four calendar years.
Rockyford is subject to a 40% income-tax rate for all ordinary income and capital gains and has a 11% weighted-average after-tax cost of capital. All operating and tax cash flows are assumed to occur at year-end. (For Parts 2 and 3, use the relevant table from Appendix CâTable 1 or Table 2.)
Required:
1. Determine the after-tax cash flow arising from disposing of the old machinery.
2. Determine the present value of the after-tax cash flows for the next four years attributable to the cash operating savings. (Round your answer to the nearest whole dollar amount.)
3. Determine the present value of the tax shield effect of depreciation for year 1. (Round your answer to the nearest whole dollar amount.)
4. Which one of the following is the proper treatment for the additional $2,300 of net working capital required in the current year?
It should be ignored in capital budgeting because it is not a capital investment. It is a sunk cost that needs no consideration in capital budgeting. It should be treated as part of the initial investment when determining the net present value. It should be spread over the machineryâs four-year life as a cash outflow in each of the years. It should be included as part of the cost of the new machine and depreciated.
May I please receive a step-by-step walkthough for each problem.
| Rockyford Company must replace some machinery that has zero book value and a current market value of $1,600. One possibility is to invest in new machinery costing $41,000. This new machinery would produce estimated annual pretax cash operating savings of $16,400. Assume the new machine will have a useful life of four years and depreciation of $10,250 each year for book and tax purposes. It will have no salvage value at the end of four years. The investment in this new machinery would require an additional $2,300 investment of net working capital. (Assume that when the old machine was purchased the incremental net working capital required at the time was $0.) |
| If Rockyford accepts this investment proposal, the disposal of the old machinery and the investment in the new one will occur on December 31 of this year. The cash flows from the investment will occur during the next four calendar years. |
| Rockyford is subject to a 40% income-tax rate for all ordinary income and capital gains and has a 11% weighted-average after-tax cost of capital. All operating and tax cash flows are assumed to occur at year-end. (For Parts 2 and 3, use the relevant table from Appendix CâTable 1 or Table 2.) |
| Required: |
| 1. | Determine the after-tax cash flow arising from disposing of the old machinery. |
| 2. | Determine the present value of the after-tax cash flows for the next four years attributable to the cash operating savings. (Round your answer to the nearest whole dollar amount.) |
| 3. | Determine the present value of the tax shield effect of depreciation for year 1. (Round your answer to the nearest whole dollar amount.) |
| 4. | Which one of the following is the proper treatment for the additional $2,300 of net working capital required in the current year? | ||||||||||
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Related questions
(Ignore income taxes in this problem.) Simpson Beauty ProductsCorporation is considering the production of a new conditioningshampoo that will require the purchase of new mixing machinery. Themachinery will cost $700,000, is expected to have a useful life of10 years, and is expected to have a salvage value of $70,000 at theend of 10 years. The machinery will also need a $45,000 overhaul atthe end of Year 5. A $60,000 increase in working capital will beneeded for this investment project. The working capital will bereleased at the end of the 10 years. The new shampoo is expected togenerate net cash inflows of $150,000 per year for each of the 10years. Simpson's discount rate is 18%.
Items | Year(s) | Amount | 18% Factor | Present Value | ||||
Cost of machinery | Now | ($700,000) | 1 | ($700,000) | ||||
Working capital increase | Now | ($60,000) | 1 | ($60,000) | ||||
Annual cash inflows | 1â10 | $150,000 | 4.494 | 674,100 | ||||
Overhaul | 5 | ($45,000) | 0.437 | ($19,665) | ||||
Salvage value | 10 | $70,000 | 0.191 | 13,370 | ||||
Working capital release | 10 | $60,000 | 0.191 | 11,460 | ||||
Net present value | ($80,735) | |||||||
Required:
(a) What is the net present value of this investmentopportunity?
(b) Based on your answer to (a) above, should Simpson go ahead withthe new conditioning shampoo?
(Ignore income taxes in thisproblem.) Sampson Beauty Products Corporation is considering theproduction of a new conditioning shampoo that will require thepurchase of new mixing machinery. The machinery will cost $550,000,is expected to have a useful life of 10 years, and is expected tohave a salvage value of $55,000 at the end of 10 years. Themachinery will also need a $35,000 overhaul at the end of Year 5. A$50,000 increase in working capital will be needed for thisinvestment project. The working capital will be released at the endof the 10 years. The new shampoo is expected to generate net cashinflows of 95,000 per year for each of the 10 years.Sampson's discount rate is16%.
Items | Year(s) | Amount | 16% Factor | Present Value | ||||
Cost of machinery | Now | ($550,000) | 1 | ($550,000) | ||||
Working capital increase | Now | ($50,000) | 1 | ($50,000) | ||||
Annual cash inflows | 1â10 | $95,000 | 4.833 | 459,135 | ||||
Overhaul | 5 | ($35,000) | 0.476 | ($16,660) | ||||
Salvage value | 10 | $55,000 | 0.227 | 12,485 | ||||
Working capital release | 10 | $50,000 | 0.227 | 11,350 | ||||
Net present value | ($133,690) | |||||||
Required:
What is the net present value of this investment opportunity?
Based on your answer to (a) above, should Sampson go ahead with thenew conditioning shampoo?
