29. The Spartan Technology Company has a proposed contract with the Digital Systems Company of Michigan. The initial investment in land and equipment will be $120,000. Of this amount, $70,000 is subject to five-year MACRS depreciation. The balance is in nondepreciable property. The contract covers six years; at the end of six years, the nondepreciable assets will be sold for $50,000, which is their original cost. The depreciated assets will have zero resale value.
The contract will require an additional investment of $55,000 in working capital at the beginning of the first year and, of this amount, $25,000 will be returned to the Spartan Technology Company after six years.
The investment will produce $50,000 in income before depreciation and taxes for each of the six years. The corporation is in a 40 percent tax bracket and has a 10 percent cost of capital.
Should the investment be undertaken? Use the net present value method.
30. An asset was purchased three years ago for $140,000. It falls into the five-year category for MACRS depreciation. The firm is in a 35 percent tax bracket. Compute the:
a. Tax loss on the sale and the related tax benefit if the asset is sold now for $15,320.
b. Gain and related tax on the sale if the asset is sold now for $58,820. (Refer to footnote 3.)
31. Polycom Technology is considering the purchase of a new piece of equipment for
$110,000. It has a nine-year midpoint of its asset depreciation range (ADR). It will require an additional initial investment of $60,000 in nondepreciable working capital. Fifteen thousand dollars of this investment will be recovered after the sixth year and will provide additional cash flow for that year. Income before depreciation and taxes for the next
six years will be:
Year Amount
1………………… $85,000
2………………… 75,000
3………………… 60,000
4………………… 52,500
5………………… 45,000
6………………… 40,000
The tax rate is 30 percent. The cost of capital must be computed based on
the following (round the final value to the nearest whole number):
|
|
Cost (aftertax) |
Weights |
| Debt………………………………………………….. |
Kd |
7.0% |
40% |
| Preferred stock……………………………………. |
Kp |
10.0 |
10 |
| Common equity (retained earnings)……….. |
Ke |
16.0 |
50 |
a. Determine the annual depreciation schedule.
b. Determine annual cash flow. Include recovered working capital in the sixth year.
c. Determine the weighted average cost of capital.
d. Determine the net present value. Should Polycom Technology purchase the new equipment?
32. Graphic Systems purchased a computerized measuring device two years ago for $80,000. It falls into the five-year category for MACRS depreciation. The equipment can currently be sold for $28,400.
A new piece of equipment will cost $210,000. It also falls into the five-year category for MACRS depreciation.
Assume the new equipment would provide the following stream of added cost savings for the next six years.
| Year |
Cash Flow |
| 1……………. |
$76,000 |
| 2……………. |
66,000 |
| 3……………. |
62,000 |
| 4……………. |
60,000 |
| 5……………. |
56,000 |
| 6……………. |
42,000 |
The tax rate is 34 percent and the cost of capital is 12 percent.
a. What is the book value of the old equipment?
b. What is the tax loss on the sale of the old equipment?
c. What is the tax benefit from the sale?
d. What is the cash inflow from the sale of the old equipment?
e. What is the net cost of the new equipment? (Include the inflow from the sale of the old equipment.)
f. Determine the depreciation schedule for the new equipment.
g. Determine the depreciation schedule for the remaining years of the old equipment.
h. Determine the incremental depreciation between the old and new equipment and the related tax shield benefits.
i. Compute the aftertax benefits of the cost savings.
j. Add the depreciation tax shield benefits and the aftertax cost savings, and determine the present value. (See Table 12-17 as an example.)
k. Compare the present value of the incremental benefits (j) to the net cost of the new equipment (e). Should the replacement be undertaken?
COMPREHENSIVE PROBLEM
The Woodruff Corporation purchased a piece of equipment three years ago for $230,000. It has an asset depreciation range (ADR) midpoint of eight years. The old equipment can be sold for $90,000.
A new piece of equipment can be purchased for $320,000. It also has an ADR of eight years.
Assume the old and new equipment would provide the following operating gains (or losses) over the next six years.
|
New Equipment |
Old Equipment |
| 1…………. |
$80,000 |
$25,000 |
| 2…………. |
76,000 |
16,000 |
| 3…………. |
70,000 |
9,000 |
| 4…………. |
60,000 |
8,000 |
| 5…………. |
50,000 |
6,000 |
| 6…………. |
45,000 |
(7,000) |
The firm has a 36 percent tax rate and a 9 percent cost of capital. Should the new equipment be purchased to replace the old equipment?
