Depreciation and New Equipment

Scenario 1B: Purchase carrier at 0% tax rate. If the boat were to be commissioned in Hong Kong, where there is 0% corporate income tax, the value of the scrap would become $6,719,582 and the NPV after 25 years will be $977,267.

July 13 – You have baking equipment, including an oven and mixer, which you have been using for your home-based business and will now start using in the bakery. You estimate that the equipment is currently worth $5,000, and you transfer the equipment into the business in exchange for additional common stock. The equipment has a 5-year useful life.

a) In the first set of calculations, the staff used a discount rate of 20%, a five-year time horizon, and ignored taxes and terminal value. What is the relative attractiveness of these three alternatives?

The equipment is expected to cost $240,000 with a 12-year life and no salvage value. It will be depreciated on a straight-line basis. The company expects to sell 96,000 units of the equipment’s product each year. The expected annual income related to this equipment follows.

July 13 – You have baking equipment, including an oven and mixer, that you have been using for your home-based business and will now start using in the bakery. You estimate that the equipment is currently worth $5,000, and you transfer the equipment into the business in exchange for additional common stock. The equipment has a 5-year useful life.

Question Number One (1) Value the processing plant proposal. Ignore the Industrial Revenue Bond financing. Assume: Market Risk Premium 8.8%, Riskless Rate 11.41%, and Harris Long Term Debt Rate 13.5%.

Estimated machinery life: 3 years (after which there will be zero value for the equipment and no further cost savings)

In reviewing the proposal presented by Pressco, Inc. to provide new mechanical drying equipment at a cost of $2.9 million I have considered the cash flow implications of the purchase in terms of present value of the investment and estimated resulting savings, as well as possible alternatives to purchase, and the current political climate as it affects the business issues of taxation and energy policy.

Natalie estimates that all of her baking equipment will have a useful life of 5 years or 60 months and no salvage value. (Assume Natalie decides to record a full month’s worth of depreciation, regardless of when the equipment was obtained by the business.)

These amounts of tax savings should be added to the incremental cost savings for each year to come up with the total cash inflows. The present value of all these cash inflows and outflows can be calculated by discounting them at 12.19%. This rate is calculated by assuming that the purchasing power parity holds in this scenario. The company can do the feasibility analysis by looking at both from the subsidiary’s and parent’s perspective by assuming that the purchasing power parity holds. Hence, this rate can be regarded as opportunity cost of investment because it is the second best alternative for the company for investment purposes.

The option to buy for 36 months follows the same logic with one exception. In this case, the hardware is no longer estimated to have a $150/unit salvage value. Instead, it is estimated that 20% of the computers can be sold to AMG employees for $50/unit. According to EPA regulations, the other 80% must be disposed of at a cost of $50. With this in mind, the NPV of cash flows for the 36 month buying option is $(5,687,735). To compare this to the 24 month buying option, the equivalent annual cost was calculated for both scenarios. The 24 month option has an EAC of $(3,063,455) and the 36 month option has an EAC of $(2,491,097), making the 36-month option the obvious choice.

A down payment of $70,000 would be required, and a first year interest payment of $45,370 (Exhibit 9). It is expected that the two machines would run at 40% capacity bringing in incremental revenue of $613,225, and incremental operating income of $234,855. The cost breakdown structure and the incremental gains for the laser cutter and water cutter can be seen in Exhibit 10. The ROI at 40% capacity is 33.80% (Exhibit 5), which is well above the banks lending rate. The payback period at 40% capacity is the lowest of all options at 3 years (Exhibit 6). With a score of 30, this option scored the highest against the decision criteria (Exhibit 7). This is largely due strongest cash flow, highest ROI, and emphasis on maintaining a high quality product and excellent costumer service.

The present value of the net incremental cash flows, totaling $5,740K, is added to the present value of the Capital Cost Allowance (CCA) tax shield, provided by the Plant and Equipment of $599K, to arrive at the project’s NPV of $6,339K. (Please refer to Exhibit 4 and 5 for assumptions and detailed NPV calculations.) This high positive NPV means that the project will add a significant amount of value to FMI. In addition, using the incremental cash flows (excluding CCA) generated by the NPV calculation, we calculated the project’s IRR to be 28%. This means that the project will generate a higher rate of return than the company’s cost of capital of 10.05%. This is also a positive indication that the company should undertake the project.

The third scenario was ignoring the option to invest in the second-generation project and selling the equipment in year 2. We evaluated this option as a put option. First, we calculated the probabilities for going up and down based on the assumption of a risk neutral word. As a result, the probability of going upward is calculated as 0.3375 and downward probability is 0.6625. In order to determine the present value of all the sequence cash flow at the end of year 2, we calculated the upside change rate and downside change rate as 64.87% and -39.35%, respectfully. The next step is to analyze the option value by using the “Binomial Tree” method. In order to determine the present value of all the subsequence cash flow at the end of year 2, we calculated the cash flow at each node on the tree, until 2006. We discounted all the cash flow at the risk free rate at 10%. The End of Year NPV of all the subsequence cash flow at Year 2 is calculated as $7,571,752, and the selling price of the equipment at end of 2 is $4,000,000, which is the salvage value. We found the NPV of selling the machine at end of Year 2 to be -$2,951,861 as of Year 0, which is negative. The APV of the project after adding the option turned out to be -$6,321,932. This negative APV suggest that the

The upgrade of the Rotterdam plant involves implementing the Japanese technology and requires a capital expenditure of £8.0 million with £3.5 million spent today, £2.0 million on year one, £1.0 million on year two and £1.0 million on year three. This will also increase polypropylene output by 7% from current levels at a rate of 2.0% per year. In addition, gross margin will improve by 0.8% per year from 11.5% to 16.0%. After auditing the financial models, it is concluded that the static net present value of the upgrade is -£6.35 million using a discount rate of 10% and an expected inflation rate of 3% annually. The Rotterdam upgrade contains an option to switch to the speculated German technology being available in five years. The current value of the option is zero as it is deeply out-of-the-money. The total net present value of the upgrade is -£6.35 million. The incremental earnings per share of the upgrade is £ 0.0013, the payback period is 14.13 years, and the internal rate of return is 18.7%.