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Item10

Item 10 0.25 points

Assume that it is January 1, 2019, and that the Mendoza Company is considering the replacement of a machine that has been used for the past 3 years in a special project for the company. This project is expected to continue for an additional 5 years (i.e., until the end of 2023). Mendoza will either keep the existing machine for another 5 years (8 years total) or replace the existing machine now with a new model that has a 5-year estimated life. Pertinent facts regarding this decision are as follows:

Keep Existing MachinePurchase New MachinePurchase price of machine (including transportation, setup charges, etc.)$170,000$210,000Useful life (determined at time of acquisition)8years5yearsEstimated salvage value, end of 2023*$22,000$27,000Expected cash operating costs, per year:Variable (per unit produced/sold)$0.45$0.39Fixed costs (total)$27,000$26,000Estimated salvage (terminal) values:January 1, 2019$70,000December 31, 2023$15,000$26,000Net working capital committed at time of acquisition of existing machine (all fully recovered at end of project, December 31, 2023)$32,000Incremental net working capital required if new machine is purchased on January 1, 2019 (all fully recovered at end of project, December 31, 2023)$12,000Expected annual volume of output/sales (in units), over the period 2019-2023520,000520,000

*Note: These amounts are used for depreciation calculations.

Assume further that Mendoza is subject to a 40% income tax, both for ordinary income and gains/losses associated with disposal of machinery, and that all cash flows occur at the end of the year, except for the initial investment. Assume that straight-line depreciation is used for tax purposes and that any tax associated with the disposal of machinery occurs at the same time of the related transaction.

Required:

1. Determine relevant cash flows (after-tax) at time of purchase of the new machine (i.e., time 0: January 1, 2019).

2. Determine the relevant (after-tax) cash inflow each year of project operation (i.e., at the end of each of years 1 through 5).

3. Determine the relevant (after-tax) cash inflow at the end of the project's life (i.e., at the project's disposal time, December 31, 2023).

5. Determine the undiscounted net cash flow (after tax) for the new machine and determine whether on this basis the old machine should be replaced.

# 2

Lou Lewis, the president of Lewisville Company, has asked you to give him an analysis of the best use of a warehouse the company owns.

1. Lewisville Company is currently leasing the warehouse to another company for $5,200 per month on a year-to-year basis. (Hint: Use the PV function in Excel to calculate, on an after-tax basis, the PV of this stream ofmonthlyrentalreceipts.)
2. The warehouse's estimated sales value is $205,000. A commercial realtor believes that the price is likely to remain unchanged in the near future. The building originally cost $61,000 and is being depreciated at $1,600 annually. Its current net book value (NBV) is $7,600.
3. Lewisville Company is seriously considering converting the warehouse into a factory outlet for furniture. The remodeling will cost $110,000 and will be modest because the major attraction will be rock-bottom prices. The remodeling cost will be depreciated over the next 5 years using the double-declining-balance method. (Note: Use the VDB function in Excel to calculate depreciation charges. The advantage of using the VDB, rather than the DDB, function is that there is a (default) option in the former that provides an automatic switch to the straight-line method when it is advantageous to do so.)
4. The inventory and receivables (net of current liabilities) needed to open and sustain the factory outlet would be $615,000. This total is fully recoverable whenever operations terminate.
5. Lou is fairly certain that the warehouse will be condemned in 10 years to make room for a new highway. The firm most likely would receive $210,000 from the condemnation.
6. Estimated annual operating data, exclusive of depreciation, are as follows:

Sales (cash)$910,000Operating expenses$510,000

1. Nonrecurring sales promotion costs at the beginning of year 1 (i.e., time 0) are expected to be $103,000. (These costs are fully deductible for tax purposes.)
2. Nonrecurring termination costs at the end of year 5 are $52,000. (These costs are fully deductible for tax purposes.)
3. The after-tax discount rate for capital budgeting purposes is 12%. (To calculate the present value factor for each year,i,i= 1, 5, use the following formula: PV factor_i= (1 1.12ⁱ). The company is in the 39% tax bracket (federal and state combined).

Required:

1. Show how you would handle the individual items in determining whether the company should continue to lease the space or convert it to a factory outlet. Use PV function in Excel, VDB function in Excel to calculate annual depreciation charges. Use NPV function to calculate depreciation tax savings.

ItemDescriptionPV012345a.After-tax monthly rent foregone

$

38,064

$

38,064

$

38,064

$

38,064

$

38,064b.All are irrelevantc.Remodeling cost (capitalized)

$

(110,000)

$

(110,000)Depreciation tax savings (DDB method; @39%)d.Investment in net working capital

$

(615,000)

$

(615,000)e.Recovery of net working capitalf.After-tax cash salesAfter-tax cash operating expensesg.After-tax sales promotion cost, year 0h.After-tax termination cost, year 5NPV =

2. Indicate which course of action, based only on these data, should be taken.