Test 2 workshop - with answers

# Test 2 workshop - with answers - You are considering the...

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You are considering the purchase of new production equipment. If the new equipment is purchased, the old equipment (which is fully depreciated) can be sold for \$50,000. The new equipment will cost \$400,000. If the new equipment is purchased, the company’s revenues will increase by \$175,000 and costs by\$25,000 each year of the equipments 3 year life. The new machine will be depreciated using a three year MACRS schedule (33.0%, 45%, 15%, and 7%). At the end of the life of the equipment, you expect that it can be sold for \$10,000. The firm has a marginal tax rate of 40% and the cost of capital on this project is 20%. Find and interpret the project’s NPV and IRR

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0 1 2 3 Cost (400) Sale of old* 30 Rev 175 175 175 -op.cost 25 25 25 -depr 132 180 60 EBT 18 -30 90 -Tax (40%) 7.2 (12) 36 NI 10.8 (18) 54 +Depr 132 180 60 +sale 10
+Sale tax shield** 7.2 =CF (370) 142.8 162 131.2 NPV = -62,574 IRR = 8.796% Therefore, REJECT!! ** Sale tax shield *Sale of Old BV = 28 BV = 0 -sale 10

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Sale = 50 Loss 18 Gain = 50 Tax shield = loss x tax rate = 18 x .4 = 7.2 Tax = 20
The Taiheiyo Chemical Corporation Problem The Taiheiyo Chemical Corporation is considering replacing a 5-year-old machine that originally cost \$50,000, presently has a book value of \$25,000, and could be sold for \$60,000. This machine is currently being depreciated using the simplified straight-line method down to a terminal value of zero over the next 5 years, generating depreciation of \$5,000 per year.

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