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Chapter 06 - Making Capital Investment Decisions
Notice the calculation of the cash flow at time 0. The capital spending on equipment and investment in net working capital are cash outflows. The aftertax selling price of the land is also a cash outflow. Even though no cash is actually spent on the land because the company already owns it, the aftertax cash flow from selling the land is an opportunity cost, so we need to include it in the analysis. With all the project cash flows, we can calculate the NPV, which is:
NPV = –$4,120,000 + $1,146,625 / 1.13 + $1,393,559 / 1.132 + $1,246,279 / 1.133 + $2,274,825 / 1.134 NPV = $265,791.25
The company should accept the new product line.
Replacement decision analysis is the same as the analysis of two competing projects, in this case, keep the current equipment, or purchase the new equipment. We will consider the purchase of the new machine first. Purchase new machine:
The initial cash outlay for the new machine is the cost of the new machine. We can calculate the operating cash flow created if the company purchases the new machine. The maintenance cost is an incremental cash flow, so using the pro forma income statement, and adding depreciation to net income, the operating cash flow created each year by purchasing the new machine will be:
Maintenance cost Depreciation EBT Taxes
Net income OCF
$330,000 860,000 –$1,190,000 –476,000 –$714,000 $146,000
25.
Notice the taxes are negative, implying a tax credit. The new machine also has a salvage value at the end of five years, so we need to include this in the cash flows analysis. The after