ABC Manufacturing Limited has a machine currently in use that was originally
purchased three years ago for $120,000. The firm depreciates the machine on the
straight-line basis using a five-year recovery period. The present machine will last for
the next five years or, once removal and clean-up costs are taken into consideration,
it could be sold now for $70,000.
ABC can buy a new machine today for a net price of $145,000 plus installation costs
of $15,000. The proposed machine will be depreciated using a five-year straight-line
depreciation period. If the firm acquires the new machine, its working capital needs
will change: accounts receivable will increase $15,000, inventory will increase $19,000
and accounts payable will increase $16,000.
Profits before depreciation, interest and taxes (PBDIT) for the present machine are
expected to be $95,000 for each of the next five years. For the proposed machine, the
expected PBDIT for each of the next five years is:
Year 1 $105,000
Year 2 $110,000
Year 3 $120,000
Year 4 $120,000
Year 5 $120,000
The corporate tax rate for the firm is 30%.
ABC expects to be able to liquidate the proposed machine at the end of its five-year
usable life for $24,000 (after paying removal and clean-up costs). The present
machine is expected to net $8,000 on liquidation at the end of the same period. ABC
expects to recover its net working capital investment on termination of the project.
PS: Assume 30% tax for both income and capital gain)
Based on the above information, creating / using excel answer the following questions:
(i) Calculate the initial investment.
(ii) Prepare a depreciation schedule for both the proposed and the present
machine. Both machines are depreciated using a five-year recovery period.
Remember the present machine has only three years of depreciation
(iii) Calculate the operating cash inflows for ABC for both the proposed and the
(iv) Calculate the terminal cash flow associated with the project.
(v) Assuming that the cost of capital of ABC is 7.60% and the average inflation rate
for the next five years is estimated at 2.00%, calculate internal rate of return
and net present value for the present and the proposed machine. Which
alternative appears to be better. Make a recommendation (remember to
substantiate your statements). Use Excel to answer this part of the question
Parts of the assignment Maximum marks
Initial investment 5
Depreciation schedule 5
Operating cash flows 30
Terminal cash flow 5
NPV and IRR 30
Total marks 100
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