question archive FITCO is considering the purchase of new equipment
FITCO is considering the purchase of new equipment
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FITCO is considering the purchase of new equipment. The equipment costs $50,000, and an additional $ 10,000 is needed to install it. The equipment has a 5-year tax life and would be fully depreciated by the straight-line method over 5 years. The equipment would have a positive pre- tax salvage value of 30,000 at the end of Year 3, when the project would be closed down. The equipment will generate no additional revenues, but it will reduce operating expenses by $36,000 annually. An inventory investment of $6,000 is required during the life of the investment. FITCO is in the 40% tax bracket and its cost of capital is 10%. [10 points in total] a. What is the FITCO net investment outlay? [2 points) b. What is the FITCO incremental annual after-tax operating cash flow? 12 points) c. What is the terminal year after-tax non-operating cash flow at the end of year 3? [2 points d. what is the NPV of the investment?
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FITCO Net investment outlay is -$66,000
FITCO incremental annual after tax operating cash flow is $26,400
Terminal year after tax non operating cash flw at the end of year 3 is $33,600
NPV of the investment is $24,897.07
| Calculation of NPV of the Project | ||||
| Particulars | 0 | 1 | 2 | 3 |
| Initial Investment | ||||
| Cost of equipment | -50000 | |||
| Installation Cost | -10000 | |||
| Equipment Base Price (A) | -60000 | |||
| Investment in inventory (B) | -6000 | |||
| Net investment (C = A+B) | -66000 | |||
| Operating Cash Flows | ||||
| Reduction in Operating expenses (D) | 36000 | 36000 | 36000 | |
| Depreciation (E = $60,000 / 5 years) | 12000 | 12000 | 12000 | |
| Profit Before Tax (F = D-E) | 24000 | 24000 | 24000 | |
| Tax @ 40% (G = F*40%) | 9600 | 9600 | 9600 | |
| Profit After Tax (H = F-G) | 14400 | 14400 | 14400 | |
| Add back Depreciation (I = E) | 12000 | 12000 | 12000 | |
| Net Operating Cash Flows (J = H+I) | 26400 | 26400 | 26400 | |
| Terminal Value | ||||
| Sale Value (K) | 30000 | |||
| Book value (L = $12,000 * 2 years) | 24000 | |||
| Profit on sale (M = K-L) | 6000 | |||
| Tax on sale @ 40% (N = M*40%) | 2400 | |||
| After tax sale value (O = K-N) | 27600 | |||
| Receovery of investment in inventory (P) | 6000 | |||
| Net terminal value (Q = O+P) | 33600 | |||
| Total Cash flows (R = C+J+Q) | -66000 | 26400 | 26400 | 60000 |
| Discount Factor @ 10% (S) 1/(1+10%)^n n=0,1,2,3 |
1 | 0.909090909 | 0.826446281 | 0.751314801 |
| Discounted Cash flows (T = R*S) | -66000 | 24000 | 21818.18182 | 45078.88805 |
| NPV | 24897.06987 |
