Chapter 3 Prob 9, (on-line asisgnment) Salterell Textiles considering replacing the looming equipment Info: old Equipment cost

$ 79,300 age of equipment 2 yrs Life 10 yrs Depreciation method SL annual D/E 7,930 Sales price today (if sold) $ 10,800 Salvage value Increased sales revenue (after tax) Reduction in costs (after tax) tax rate 25% cost of capital 14%

New $ 80,500 8 yrs 10,063 $ 8,000 $ 9,000 per year $ 7,500

a). With a tax rate of 25%, and a cost of capital at 14%, what should Salterell's decision be, purchase new equipment of not? Calculate the NPV 1). PV of revenue & savings Revenue Savings Total PVIFA (after tax) 2. PV of new machine - cost of new machine calc the PV of depreciation

9,000 7,500 16,500 4.6389 76,541.85

(80,500)

http://www.miniwebtool.com/pvifa-calculator/?r=15&n=20
PV interest factor of an annuity

annual D/E PVIFA subtotal tax rate subtotal calc the PV(after tax salvage) salvage value taxes @ 25% subtotal PVIF subtotal

10,062.50 4.6389 46,679 25% 11,670 8,000 2,000 6,000.00 0.3506 2,103.60

PVIFA for 14% interest rate, 8 years

4.6389

PVIF Calculator
Interest rate per period: Number of period:
% 14

Calculate PVIF PVIF Result

PV of new machine 3. PV of old machine sales price of old machine A book value B A-B tax rate tax amt A - tax amount anuual depre D tax rate E PVIFA F DxExF A - DxExF 1). PV of revenue & savings PV of new machine 3. PV of old machine Grand Total NPV

(66,726.67)

0.3506

10,800 63,440 machine is 2 yrs old (52,640) 25% (13,160) 23,960 7,930 25% 4.6389 9,197 14,763.38 76,542 (66,727) 14,763 24,578.56

b). Would a 10% ITC change the analysis? An ITC would reduce the taxes by 10% 80,500 10% 8,050 The NPV of the new machine will increase PV of new machine ITC PV of new machine with ITC Overall NPV is increased (66,726.67) 8,050 (58,676.67) 32,628.56

c). If an inflation rate of 7 % a year is incorporated into the decision is the project acceptable? Inflation will increase: revenue costs salvage values It will NOT affect depreciation or the after tax value of the sale of an existing asset, (assumption is inflation was already included in the discount rate). Therefore, inflation will only make the NPV better.