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Solution Problem On Project Evaluation

The document analyzes whether a company should purchase a new executive airplane for $2.44 million. It calculates that the airplane would save $780,000 per year in management time costs and have a net present value of $77,153 over 10 years when accounting for taxes, depreciation, and required rate of return. Therefore, the airplane investment is attractive.

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79 views5 pages

Solution Problem On Project Evaluation

The document analyzes whether a company should purchase a new executive airplane for $2.44 million. It calculates that the airplane would save $780,000 per year in management time costs and have a net present value of $77,153 over 10 years when accounting for taxes, depreciation, and required rate of return. Therefore, the airplane investment is attractive.

Uploaded by

Hasan
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as XLSX, PDF, TXT or read online on Scribd
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Problem 1: Coca Cola Distribution can purchase a new executive airplane for $2,300,000.

Delivery will cost $10,000 and fitting out after delivery will cost $130,000. The
plane has a tax life of 5 years and plane will be depreciated using the MARCS method (20.00%, 32.00%, 19.20%, 11.52%, 11.52%, 5.76%). The airplane will be used to
transport its executives and will physically last for 10 years (even though it has depreciated over 5 years). At the end of 10 years the plane will have no salvage value.
Wages, repair, fuel, and so on to operate the plane are expected to total $250000 a year. The plane is expected to save 6,000 hours of management time a year. The
managers involved receive salary and benefits that average $130 an hour. The company has a 40 percent tax rate and a 12 percent required rate of return. Is the
airplane an attractive investment?

Problem 1
Initial outlay
Price of the new plane ($2,300,000)
Delivery ($10,000)
Fitting out after delivery ($130,000)
Initial Investment ($2,440,000)
Taxes 40%
Savings of Management hours 6,000
Average cost per Mangement hour 130

After tax income


Year Year 0 Year 1 2 3 4 5 6 7 8 9
Depreciation rate 20.00% 32.00% 19.20% 11.52% 11.52% 5.76%
Savings in operating cost $780,000 $780,000 $780,000 $780,000 $780,000 $780,000 $780,000 $780,000 $780,000
Increase in operating cost
($250,000) ($250,000) ($250,000) ($250,000) ($250,000) ($250,000) ($250,000) ($250,000) ($250,000)
excliding depreciation
Net increase in EBITDA, St $530,000 $530,000 $530,000 $530,000 $530,000 $530,000 $530,000 $530,000 $530,000
(1-T) St $318,000 $318,000 $318,000 $318,000 $318,000 $318,000 $318,000 $318,000 $318,000
Depreciation, Dt $488,000 $780,800 $468,480 $281,088 $281,088 $140,544
T*Dt $195,200 $312,320 $187,392 $112,435 $112,435 $56,218
Cash flows ($2,440,000) $513,200 $630,320 $505,392 $430,435 $430,435 $374,218 $318,000 $318,000 $318,000
Present value factor 1.0000 0.8929 0.7972 0.7118 0.6355 0.5674 0.5066 0.4523 0.4039 0.3606
Present
Present value
value future cash ($2,440,000) $458,214 $502,487 $359,728 $273,549 $244,240 $189,590 $143,847 $128,435 $114,674
flows $2,517,153
Net present value $77,153
will cost $130,000. The
airplane will be used to
have no salvage value.
ement time a year. The
d rate of return. Is the

10

$780,000
($250,000)

$530,000
$318,000

$318,000
0.3220
$102,387
Problem 2: A machine currently in use was originally purchased 2 years ago for $40,000. The machine is being deprecia
MARCS using a 5-year recovery period ((20%, 32%, 19%, 12%, 12%, 5%); it 3 years of usable life remaining. The current mach
sold today to net $42,000 after removal and cleanup cost. A new machine, using 3-year MACRS recovery period (33%, 45%,
can be purchased at a price $140,000. It requires $10,000 to install. If new machine is acquired, the investment in accounts
will be expected to rise by $10,000, the inventory will increase by $25,000, and accounts payable will increase by $15,000
before depreciation, interest, and taxes are expected to be $70,000 for each of the next three years with the old machine
$120,000 in the first year and $130,000 in the second and third year with the new machine. At the end of the 3 years, the ma
of the old machine will be equal to zero, but the new machine could be sold to net $35,000 before taxes. The firm is subject
rate and required rate of return 10%. Recommend on the acceptance of the project.

Tax Rate 40%


Saelling of Old Machine
Installed Cost of Old Machine 40,000
Accumulated Depreciation 20,800
Book Value 19,200
Sales Proceed 42,000
Gain 22,800
Gain Tax 9,120
After Tax Sales Proceed 32,880
Purchase of New Machine
Value of New Machine (140,000)
Installation Cost (10,000)
Installed Cost of Old Machine (150,000)
Net working Capital
Increase in Account Receivable (10,000)
Increase in Inventory (25,000)
Increase in Account Payable 15,000
Net working Capital (20,000)

Depreciation Schedule of New Machine 33% 45% 15%


Depreciation Schedule of Old Machine 20% 32% 19%

Operating Cash Flows 1 2 3


EBITDA of Old Machine 70,000 70,000 70,000
EBITDA of New Machine 120,000 130,000 130,000
Incremental EBITDA 50,000 60,000 60,000
Depreciation of New Machine 49,500 67,500 22,500
Depreciation of old Machine 7,600 4,800 4,800
Incremental Depreciation 41,900 62,700 17,700
After Tax Cash Flows (137,120) 46,760 61,080 43,080

Terminal Value
Old Machine
Market Value -
Book Value 2,000
Tax Rebate 800

New Machine
Sales Proceed 35,000
Book Value 10,500
Gain 24,500
Gain Tax 9,800
After Tax Sales Proceed 25,200
Recovery of Net Working Capital 20,000
Incremental Terminal Cash Flow 44,400

- 1 2 3
After Tax Total Cash Flows (137,120) 46,760 61,080 87,480
PVIF at 10% 1.0000 0.9091 0.8264 0.7513
Cumulative Cash Flows (137,120) (90,360) (29,280) 58,200
NPV 21,593

NPV is Positive, so we shall accept the replacement.


0. The machine is being depreciated under
life remaining. The current machine can be
ACRS recovery period (33%, 45%, 15%, 7%),
ired, the investment in accounts receivable
payable will increase by $15,000. Earnings
hree years with the old machine and to be
At the end of the 3 years, the market value
before taxes. The firm is subject to 40% tax

7%
12% 12% 5%

10,500
2,000
8,500

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