The Nick K Company is examining purchasing a new piece of equipment and selling the old. The
Question:
The Nick K Company is examining purchasing a new piece of equipment and selling the old.
The old system is currently one year old and had an original production life of 7years. It had cost $850,000 and was being depreciated using 100% bonus. Nick estimated that it could be sold for $40,000 at the end of its production life and this is still true.
The new will take one year to build and install and require an investment of $400,000 today and $700,000 one year from now. It will have a production life of five years and be depreciated using 100 % bonus. We will also increase working capital by $90,000 when it is ready for use.
The old is projected to produce cash revenue of $900,000 this coming year and that will decrease 10% per year for the rest of its production life. Cash expenses are expected to be 50% of revenue (not including taxes). The old will be used until the new is put in service.
The new will produce $1,000,000 its first year of production, $1,700,000 its second year, $1,900,000 its third year, $1,000,000 its fourth year and $500,000 its last year. Expenses are expected to be 40% of revenue (not including taxes). We expect to sell it for $450,000 at the end of its production life. We estimate we can sell the working capital for $90,000 at that time.
We estimate that the old could be sold for $100,000 when the new is ready for use.
Nick requires a 20% return on this project and has a 30% tax rate. Based on net present value, should you purchase the new system? SHOW ALL WORK!!!!!
Foundations of Financial Management
ISBN: 978-1259024979
10th Canadian edition
Authors: Stanley Block, Geoffrey Hirt, Bartley Danielsen, Doug Short, Michael Perretta