Can you please help me understand how to figure the MACRS percentage and the discount factor for year 1 of .893?

NPV With Tax Shield

Philadelphia Fastener Corporation manufactures nails, screws, bolts, and other fasteners. Management is considering a proposal to acquire new material-handling equipment. The new equipment has the same capacity as the current equipment but will provide operating efficiencies in labor and power usage. The savings in operating costs are estimated at $150,000 annually.

The new equipment will cost $300,000 and will be purchased at the beginning of the year when the project is started. The equipment dealer is certain that the equipment will be operational during the second quarter of the year it is installed. Therefore, 60 percent of the estimated annual savings can be obtained in the first year. The company will incur a one-time expense of $30,000 to transfer production activities from the old equipment to the new equipment. No loss of sales will occur, however, because the processing facility is large enough to install the new equipment without interfering with the operations of the current equipment. The equipment is in the MACRS 7-year property class. The firm would depreciate the machinery in accordance with the MACRS depreciation schedule.

The current equipment has been fully depreciated. Management has reviewed its condition and has concluded that it can be used an additional eight years. The company would receive $10,000, net of removal costs, if it elected to buy the new equipment and dispose of its current equipment at this time. The new equipment will have no salvage value at the end of its life. The company is subject to a 40 percent income-tax rate and requires an after-tax return of at least 12 percent on any investment.

Required:

1.Calculate the annual incremental after-taxcash flowsfor Philadelphia Fastener Corporation's proposal to acquire the new equipment.

2.Calculate the net present value of the proposal to acquire the new equipment using the cash flows calculated in requirement (1), and indicate what action management should take. Assume all cash flows take place at the end of the year.

MARCS rates: 14.29%, 24.49%, 17.49%, 12.49%, 8.93%, 8.92%, 8.93%, 4.46%

Problem 16-49

1.Calculation of incremental after-tax cash flows:

Purchase

Time 0

Purchase of new equipment ..............................................................

$(300,000

)

One-time transfer expense

net of tax ($30,000 .6) ...................................................................

(18,000

)

Sale of old equipment

net of tax on gain ($10,000 .6) ......................................................

6,000

Total initial cash outflow ....................................................................

$(312,000

)

Problem 16-49 (Continued)

Annual Operation

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Year 7

Year 8

Cash operating savings

$90,000

*

$150,000

$150,000

$150,000

$150,000

$150,000

$150,000

$150,000

Less tax effect (40%)

36,000

60,000

60,000

60,000

60,000

60,000

60,000

60,000

Cash savings after tax

$54,000

$90,000

$90,000

$90,000

$90,000

$90,000

$90,000

$90,000

Depreciation tax shield

(see following schedule)

17,148

29,388

20,988

14,988

10,716

10,704

10,716

5,352

After-tax operating cash flows

$71,148

$119,388

$110,988

$104,988

$100,716

$100,704

$100,716

$95,352

*$90,000 = $150,000 60%

Problem 16-49 (Continued)

Depreciation Schedule

Year

MACRS

Percentage

Depreciation

(MACRS Rate $300,000)

Tax

Rate

Depreciation

Tax Shield

1

14.29%

$42,870

40%

$17,148

2

24.49%

73,470

40%

29,388

3

17.49%

52,470

40%

20,988

4

12.49%

37,470

40%

14,988

5

8.93%

26,790

40%

10,716

6

8.92%

26,760

40%

10,704

7

8.93%

26,790

40%

10,716

8

4.46%

13,380

40%

5,352

2.Net present value analysis:

Year

After-Tax

Cash Flow

Discount Factor

(r = 12%)

Present

Value

0

$(312,000

)

1.000

$(312,000

)

1

71,148

.893

63,535

2

119,388

.797

95,152

3

110,988

.712

79,023

4

104,988

.636

66,772

5

100,716

.567

57,106

6

100,704

.507

51,057

7

100,716

.452

45,524

8

95,352

.404

38,522

Net present value

$184,691

Recommendation:

Management should purchase the new equipment because the proposal's net present value is positive.NPV With Tax Shield

Philadelphia Fastener Corporation manufactures nails, screws, bolts, and other fasteners. Management is considering a proposal to acquire new material-handling equipment. The new equipment has the same capacity as the current equipment but will provide operating efficiencies in labor and power usage. The savings in operating costs are estimated at $150,000 annually.

The new equipment will cost $300,000 and will be purchased at the beginning of the year when the project is started. The equipment dealer is certain that the equipment will be operational during the second quarter of the year it is installed. Therefore, 60 percent of the estimated annual savings can be obtained in the first year. The company will incur a one-time expense of $30,000 to transfer production activities from the old equipment to the new equipment. No loss of sales will occur, however, because the processing facility is large enough to install the new equipment without interfering with the operations of the current equipment. The equipment is in the MACRS 7-year property class. The firm would depreciate the machinery in accordance with the MACRS depreciation schedule.

The current equipment has been fully depreciated. Management has reviewed its condition and has concluded that it can be used an additional eight years. The company would receive $10,000, net of removal costs, if it elected to buy the new equipment and dispose of its current equipment at this time. The new equipment will have no salvage value at the end of its life. The company is subject to a 40 percent income-tax rate and requires an after-tax return of at least 12 percent on any investment.

Required:

1.Calculate the annual incremental after-taxcash flowsfor Philadelphia Fastener Corporation's proposal to acquire the new equipment.

2.Calculate the net present value of the proposal to acquire the new equipment using the cash flows calculated in requirement (1), and indicate what action management should take. Assume all cash flows take place at the end of the year.

MARCS rates: 14.29%, 24.49%, 17.49%, 12.49%, 8.93%, 8.92%, 8.93%, 4.46%

Problem 16-49

1.Calculation of incremental after-tax cash flows:

Purchase

Time 0

Purchase of new equipment ..............................................................

$(300,000

)

One-time transfer expense

net of tax ($30,000 .6) ...................................................................

(18,000

)

Sale of old equipment

net of tax on gain ($10,000 .6) ......................................................

6,000

Total initial cash outflow ....................................................................

$(312,000

)

Problem 16-49 (Continued)

Annual Operation

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Year 7

Year 8

Cash operating savings

$90,000

*

$150,000

$150,000

$150,000

$150,000

$150,000

$150,000

$150,000

Less tax effect (40%)

36,000

60,000

60,000

60,000

60,000

60,000

60,000

60,000

Cash savings after tax

$54,000

$90,000

$90,000

$90,000

$90,000

$90,000

$90,000

$90,000

Depreciation tax shield

(see following schedule)

17,148

29,388

20,988

14,988

10,716

10,704

10,716

5,352

After-tax operating cash flows

$71,148

$119,388

$110,988

$104,988

$100,716

$100,704

$100,716

$95,352

*$90,000 = $150,000 60%

Problem 16-49 (Continued)

Depreciation Schedule

Year

MACRS

Percentage

Depreciation

(MACRS Rate $300,000)

Tax

Rate

Depreciation

Tax Shield

1

14.29%

$42,870

40%

$17,148

2

24.49%

73,470

40%

29,388

3

17.49%

52,470

40%

20,988

4

12.49%

37,470

40%

14,988

5

8.93%

26,790

40%

10,716

6

8.92%

26,760

40%

10,704

7

8.93%

26,790

40%

10,716

8

4.46%

13,380

40%

5,352

2.Net present value analysis:

Year

After-Tax

Cash Flow

Discount Factor

(r = 12%)

Present

Value

0

$(312,000

)

1.000

$(312,000

)

1

71,148

.893

63,535

2

119,388

.797

95,152

3

110,988

.712

79,023

4

104,988

.636

66,772

5

100,716

.567

57,106

6

100,704

.507

51,057

7

100,716

.452

45,524

8

95,352

.404

38,522

Net present value

$184,691

Recommendation:

Management should purchase the new equipment because the proposal's net present value is positive.