***Please Use This Template***
C12-40. LO2, 5, 6 NPV and Project Reevaluation with Taxes, Straight-Line Depreciation In 2015, the Bayside Chemical Company prepared the following analysis of an investment proposal for a new manufacturing facility: Predicted Cash Inflows (outflows) (A) Year(s) of Cash Flows (B) 12% Present Value Factor (C) Present Value of Cash Flows (A) X (C) $(810,000) (100,000) 0 0 1.00000 1.00000 $ (810,000) (100,000) Initial investment Fixed assets Working capital Operations Annual taxable income without depreciation Taxes on income ($310,000 0.40). Depreciation tax shield .. Disinvestment Site restoration Tax shield of restoration ($80,000 X 0.40) Working capital .. Net present value of all cash flows.. 310,000 (124,000) 64,800* 1-5 1-5 1-5 3.60478 3.60478 3.60478 1,117,482 (446,993) 233,590 80,000 32,000 100,000 5 5 5 0.56743 0.56743 0.56743 (45,394) 18,158 56,743 $ 23,586 *Computation of depreciation tax shield: Annual straight-line depreciation ($810,000 - 5). Tax rate.. $162,000 X 0.40 Depreciation tax shield $ 64,800 Because the proposal had a positive net present value when discounted at Bayside's cost of capi- tal of 12 percent, the project was approved; all investments were made at the end of 2016. Shortly after production began in January 2017, a government agency notified Bayside of required additional expenditures totaling $200,000 to bring the plant into compliance with new federal emission regu- lations. Bayside has the option either to comply with the regulations by December 31, 2017, or to sell the entire operation (fixed assets and working capital) for $250,000 on December 31, 2017. The improvements will be depreciated over the remaining four-year life of the plant using straight-line depreciation. The cost of site restoration will not be affected by the improvements. If Bayside elects to sell the plant, any book loss can be treated as an offset against taxable income on other operations. This tax reduction is an additional cash benefit of selling. Required a. Should Bayside sell the plant or comply with the new federal regulations? To simplify calculations, assume that any additional improvements are paid for on December 31, 2017. Present Value of Selling Plant at 12/31/2017 250,000 Cash from sale of plant Tax shield of loss on sale: Selling Price Book Value Loss on sale Tax shield Proceeds from selling plant 250,000 Present Value of Additional Investment Predicted Cash Inflows (outflows) (A) Year(s) of Cash Flows (B) 12% Present Value Factor (C) Present Value of Cash Flows (A)(C) 200,000 0 1 Initial investment Fixed assets Operations Annual taxable income w/o depreciation Taxes on income ($310,000 x 0.40) Depreciation tax shield - original Depreciation tax shield - additional Disinvestment Site restoration Tax shield of restoration ($80,0000 x 0.40) Working capital Net present value of all cash flows $ 6 ***With the exception of Year(s) of Cash Flows and 12% Present Value Factor, you should enter formulas with cell references - NO HARD-KEYED NUMBERS C12-40. LO2, 5, 6 NPV and Project Reevaluation with Taxes, Straight-Line Depreciation In 2015, the Bayside Chemical Company prepared the following analysis of an investment proposal for a new manufacturing facility: Predicted Cash Inflows (outflows) (A) Year(s) of Cash Flows (B) 12% Present Value Factor (C) Present Value of Cash Flows (A) X (C) $(810,000) (100,000) 0 0 1.00000 1.00000 $ (810,000) (100,000) Initial investment Fixed assets Working capital Operations Annual taxable income without depreciation Taxes on income ($310,000 0.40). Depreciation tax shield .. Disinvestment Site restoration Tax shield of restoration ($80,000 X 0.40) Working capital .. Net present value of all cash flows.. 310,000 (124,000) 64,800* 1-5 1-5 1-5 3.60478 3.60478 3.60478 1,117,482 (446,993) 233,590 80,000 32,000 100,000 5 5 5 0.56743 0.56743 0.56743 (45,394) 18,158 56,743 $ 23,586 *Computation of depreciation tax shield: Annual straight-line depreciation ($810,000 - 5). Tax rate.. $162,000 X 0.40 Depreciation tax shield $ 64,800 Because the proposal had a positive net present value when discounted at Bayside's cost of capi- tal of 12 percent, the project was approved; all investments were made at the end of 2016. Shortly after production began in January 2017, a government agency notified Bayside of required additional expenditures totaling $200,000 to bring the plant into compliance with new federal emission regu- lations. Bayside has the option either to comply with the regulations by December 31, 2017, or to sell the entire operation (fixed assets and working capital) for $250,000 on December 31, 2017. The improvements will be depreciated over the remaining four-year life of the plant using straight-line depreciation. The cost of site restoration will not be affected by the improvements. If Bayside elects to sell the plant, any book loss can be treated as an offset against taxable income on other operations. This tax reduction is an additional cash benefit of selling. Required a. Should Bayside sell the plant or comply with the new federal regulations? To simplify calculations, assume that any additional improvements are paid for on December 31, 2017. Present Value of Selling Plant at 12/31/2017 250,000 Cash from sale of plant Tax shield of loss on sale: Selling Price Book Value Loss on sale Tax shield Proceeds from selling plant 250,000 Present Value of Additional Investment Predicted Cash Inflows (outflows) (A) Year(s) of Cash Flows (B) 12% Present Value Factor (C) Present Value of Cash Flows (A)(C) 200,000 0 1 Initial investment Fixed assets Operations Annual taxable income w/o depreciation Taxes on income ($310,000 x 0.40) Depreciation tax shield - original Depreciation tax shield - additional Disinvestment Site restoration Tax shield of restoration ($80,0000 x 0.40) Working capital Net present value of all cash flows $ 6 ***With the exception of Year(s) of Cash Flows and 12% Present Value Factor, you should enter formulas with cell references - NO HARD-KEYED NUMBERS
