Manchester Company is considering a proposal to purchase special equipment at a cost of $660,000. The equipment
Question:
Manchester Company is considering a proposal to purchase special equipment at a cost of $660,000. The equipment will be useful for five years and has an expected $65,000 salvage value. Manchester expects annual savings in cash operating expenses (before taxes) of $235,000. For tax purposes, the annual depreciation deduction will be as follows (salvage value is ignored on the tax return):
Year 1 | $82,500 |
Year 2 | 165,000 |
Year 3 | 165,000 |
Year 4 | 165,000 |
Year 5 | 82,500 |
The income tax rate is 40%.
Manchester establishes a hurdle rate for a net present value analysis at the company's weighted average cost of capital plus 2 percentage points. Manchester's capital is provided in the following proportions: debt, 70%; common stock, 20%; and retained earnings, 10%. The cost rates for these capital sources are debt, 8%; common stock, 12%; and retained earnings, 10%.
a. Compute Manchester's (1) weighted average cost of capital and (2) hurdle rate.
Round answers to one decimal place. For example, 0.4567 = 45.7%.
Weighted Average Cost of Capital | |
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Debt | Answer |
Common stock | Answer |
Retained earnings | Answer |
(1) Weighted avg. cost of capital | Answer |
(2) Manchester's cut off rate: | Answer |
b. Using Manchester's hurdle rate, compute the net present value of this capital expenditure proposal.
Round answers to the nearest whole number. Use rounded answers for subsequent calculations. Use a negative sign with net present value to indicate a negative amount. Otherwise do not use negative signs with your answers.
After-Tax Cash Flow Analysis | ||
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Amount | Present Value | |
After-tax cash expense savings | Answer | Answer |
Tax savings from depreciation | ||
Year 1 | Answer | Answer |
Year 2 | Answer | Answer |
Year 3 | Answer | Answer |
Year 4 | Answer | Answer |
Year 5 | Answer | Answer |
After-tax equipment sale proceeds | Answer | Answer |
Total present value of future cash flows | Answer | |
Investment required in equipment | Answer | |
Net positive (negative) present value | Answer |
Under the net present value analysis, should Manchester accept the proposal?
Select the most appropriate answer below.
Manchester should not accept the proposal, because its net present value is positive.
Manchester should accept the proposal, because its net present value is negative.
Manchester should accept the proposal, because its net present value is positive.
Manchester should not accept the proposal, because its net present value is negative.
Managerial Accounting An Introduction to Concepts Methods and Uses
ISBN: 978-0324639766
10th Edition
Authors: Michael W. Maher, Clyde P. Stickney, Roman L. Weil