Problem A$-22($Static$)$ Compute Net Present Value

Lodi Fabrication is evaluating a proposal to purchase a new turbine to replace a less efficient machine presently in use. The cost of the new equipment at time $0,$ including delivery and installation, is $$450,000.$ If it is purchased, Lodi will incur costs of $$25,000$ to remove the present equipment and revamp its facilities. This $$25,000$ is tax deductible at time $0.$

Depreciation on the new machine for tax purposes will be allowed as follows: year $1,$ $$90,000$; year $2,$ $$157,500$; and in each of years $3$ through $5,$ $$67,500$ per year. The existing equipment has a book and tax value of $$250,000$ and a remaining useful life of $10$ years. However, the existing equipment can be sold for only $$100,000$ 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.

$$Present EquipmentNew EquipmentAnnual capacity $($units$)900,000900,000$Annual costs:$$Labor$ $67,500$$ $56,000$Depreciation$22,50031,000$Other $($all cash$)108,00045,000$Total annual costs$ $198,000$$ $132,000$

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 $$135,000$ at the end of $10$ years, which will be taxable, and no removal costs. No changes in working capital are required with the purchase of the new equipment. The sales force does not expect any changes in the volume of sales over the next $10$ years. The company$$s cost of capital is $18$ percent, and its tax rate is $20$ percent. Use$$Exhibit A$\mathrm{.}8.$

Required:

Calculate the removal costs of the existing equipment net of tax effects.

Compute the depreciation tax shield.

Note: Round PV factor to $3$ decimal places.

Compute the annual 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 years $1$ through $10.$

Compute the net present value of the project.

Note: Round your intermediate values to the nearest whole dollars. Round PV factor to $3$ decimal places. Negative amounts should be indicated by a minus sign.

Problem A$-22($Static$)$ Compute Net Present Value

points

References

Lodi Fabrication is evaluating a proposal to purchase a new turbine to replace a less efficient machine presently in use. The cost of the new equipment at time $0,$ including delivery and installation, is $\backslash (\backslash$$ $450,000\backslash ).$ If it is purchased, Lodi will incur costs of $\backslash (\backslash$$ $25,000\backslash )$ to remove the present equipment and revamp its facilities. This $\backslash (\backslash$$ $25,000\backslash )$ is tax deductible at time $0.$

Depreciation on the new machine for tax purposes will be allowed as follows: year $1,\backslash$$$90,000$; year $\backslash (2,\backslash$$ $157,500\backslash )$; and in each of years $3$ through $\backslash (5,\backslash$$ $67,500\backslash )$ per year. The existing equipment has a book and tax value of $\backslash (\backslash$$ $250,000\backslash )$ and a remaining useful life of $10$ years. However, the existing equipment can be sold for only $\backslash (\backslash$$ $100,000\backslash )$ 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.

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 $\backslash (\backslash$$ $135,000\backslash )$ at the 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 $18$ percent, and its tax rate is $20$ percent. Use Exhibit A$.8.$

Required:

a$.$ Calculate the removal costs of the existing equipment net of tax effects.

b$.$ Compute the depreciation tax shield.

Note: Round PV factor to $3$ decimal places.

c$.$ Compute the annual forgone tax benefits of the old equipment.

d$.$ Calculate the cash inflow, net of taxes, from the sale of the new equipment in year $10.$

e$.$ Calculate the tax benefit arising from the loss on the old equipment.

f$.$ Compute the annual differential cash flows arising from the investment in years $1$ through $10.$

g$.$ Compute the net present value of the project.

Note: Round your intermediate values to the nearest whole dollars. Round PV factor to $\backslash (\backslash$mathbf$\{3\}\backslash )$ decimal places. Negative amounts should be indicated by a minus sign.