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Compute Net Present Value
Dungan Corporation is evaluating a
proposal to purchase a new drill press to replace a less efficient
machine presently in use. The cost of the new equipment at time 0,
Including delivery and installation, is $200,000. If it is purchased.
Dungan will incur costs of $5,000 to remove the present equipment and
revamp its facilities. This 5, $30,000 per year. The existing equipment
has a book and tax value of $100,000 and a remaining useful life of 10
years. However, the existing equipment can be sold for only $40,000 and
is being depreciated for book and tax purposes using the straight-line
method over its actual life.
Management has provided you with the following comparative manufacturing cost data:
| Annual capacity (units) |
400,000 |
400,000 |
| Annual costs: |
|
|
| Labor |
$30,000 |
$25,000 |
| Depreciation |
10,000 |
14,000 |
| Other (all cash) |
48,000 |
20,000 |
| Total annual costs |
$88,000 |
$59,000 |
The existing equipment is expected to have a salvage value equal to
its removal costs at the end of 10 years. The new equipment is expected
to have a salvage value of $600,000 at end of 10 years, which will be
taxable, and no removal costs. No changes in working capital are
required with the purchase of the new equipment. The sales force does
not expect any changes in the volume of sales over the next 10 years.
The company’s cost of capital is 15 percent, and it tax rate is 45
percent.
Required
- Calculate the removal costs of the existing equipment net of tax effects.
- Compute the depreciation tax shield.
- Compute the forgone tax benefits of the old equipment.
- Calculate the cash inflow net of taxes from the sale of the new equipment in year 10.
- Calculate the tax benefit arising from the loss on the old equipment.
- Compute the annual differential cash flows arising from the investment in year 1 through 10.
