A Firm Is Considering an Investment of $480,000 in New

question 20

Essay

A firm is considering an investment of $480,000 in new equipment to replace old equipment with a book value of $95,000 and a market value of $63,000.If the firm replaces the old equipment with new equipment, it expects to save $120,000 in operating costs the first year.The amount of savings will grow at a rate of 8% per year for each of the following five years.Both pieces of equipment belong to asset class 8, which has a CCA rate of 20%.The salvage values of both the old equipment and the new equipment at the end of six years are $11,000 and $78,000, respectively.There are other assets in the asset class when the project terminates and the half-year rule applies in the first year.In addition, replacement of the old equipment with the new equipment requires an immediate increase in net working capital of $50,000.The firm's marginal tax rate is 35% and cost of capital is 11%.
a)What is the initial after-tax cash flow?
b)What is the present value of the incremental CCA tax savings?
c)What is the present value of the incremental after-tax operating cash flows?
d)What is the present value of the incremental ending after-tax cash flow?
e)What is the NPV of the replacement project?

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Definitions:

Traditional Overhead Costing Systems

Costing systems that allocate overhead to products based on predetermined overhead rates, often using direct labor hours or machine hours as the allocation base.

Allocated Overhead Costs

Expenses related to the indirect costs of production that are assigned to specific products or departments based on a formula or method.

Allocation Methods

Allocation methods are accounting strategies used to distribute costs or revenues among different departments, products, or processes within a company.

Overhead Costs

Indirect expenses related to the operation of a business that are not directly assignable to a specific product or service.