Case Study

Read this case study and then answer the questions that follow.

1. Janice Joplin owns the Radical Music Company and needs a new recording machine as technology is quickly changing.
2. The best machines are available in Canada. Janice decides to visit Canada to determine which machine to purchase. The cost of this trip was $12,000. Based on the trip she will purchase the Mendez 100. Once the decision is made to purchase, she will need to travel to Canada to undertake training. This will cost $10,000. Both trips are tax deductible in year 0.
3. The Mendez 100 will cost $650,000 and should be able to be sold for $100,000. The accountant has advised that the machine will be depreciated over 7 years. The ATO however requires depreciation over 6 years. It is expected that the machine will be kept for 5 years by Radical Music so any evaluation must be undertaken over a 5-year period. The accountant is adamant that depreciation will need to be over 7 years for analysing this project.
4. Janice will need to borrow 50% of the value of the Mendez 100 from the Eastern Bank. The loan will be at a fixed rate of 12% p.a. over 5 years, with interest only payable at the end of each year. The principal is repayable at the end of the fifth year.
5. The old machine was purchased three years ago and at that time was expected to have an economic life of 4 years. It cost $280,000 and Janice has been depreciating it using straight-line depreciation over four years as required by the ATO. Janice expects she will receive $120,000 if she sells the old machine. It is expected to be sold in period 0 if the new machine is purchased.
6. The Mendez machine is state-of-the-art, and much more efficient than the old machine. The old machine costs $250,000 per annum to operate, whereas the new machine will only cost about $75,000 per annum to operate.
7. Due to the different way the Mendez operates, it will be necessary to purchase an additional $80,000 of inventory in year 0.
8. Janice will need less staff because of the new machine. This will require a payout of $200,000 in year 0 and save wages of $80,000 per year. These amounts are tax deductible.
9. All cash flows are given in nominal terms.
10. The nominal rate of interest currently in the economy is 6% and inflation is 3%. The real rate of interest is 2.91% and the WACC is 7%
11. The corporate tax rate is 27%. Assume tax is paid in the year of income.
12. The new machine will generate yearly revenue of $4m while the old machine was only able to generate annual revenue of $1.9m.
13. Assume that all incremental revenues (as identified in line 12 above) and expenses (as identified in line 6 above) continue to year 5. That is, include these incremental amounts in your calculation in question 8.

1) What amount (before taxes) of the trip to Canada should be included when undertaking the NPV analysis? (1 Mark) Answer to the nearest dollar. Do not use $ or , signs in answer.

Answer: $Answer

2) The after-tax impact from Eastern Bank to be included in the NPV calculation is: (1 Mark) Answer to the nearest dollar. Do not use $ or , signs in answer

Answer: $Answer

3) The depreciation tax shield (tax benefit per annum) for the new machine is: (1 Mark) Answer to the nearest dollar. Do not use $ or , signs in answer

Answer: $Answer

4) The lost depreciation tax shield (tax benefit per annum) for the old machine is in year 5 is: (1 Mark) Answer to the nearest dollar. Do not use $ or , signs in answer

Answer: $Answer

5) Janice must purchase additional inventory. The cash flow impact of this in year 5 will be? (1Mark) Answer to the nearest dollar. Do not use $ or , signs in answer

Answer : $Answer AnswerInflowOutflow

6) The Cash Flow in period 0 is: (2 Marks) Answer to the nearest dollar. Do not use $ or , signs in answer

Answer :$Answer (a negative sign may be used in the answer)

7) The appropriate discount rate to use in deciding whether Janice should buy the new machine is. (1 Mark)

Answer : Answer (Answer as a Decimal to 4 decimal places. E.g. if the answer is 2.56% answer as .0256 only.)

8) The Free Cash Flow in year 5 is: (2 Marks) Answer to the nearest dollar. Do not use $ or , signs in answer

Answer: $Answer