QUESTION 52

Shown below are details of a capital budgeting replacement project that Dash Corporation is considering.

Dash Corp. Capital Budgeting Project

Dash Corp. is a publisher of textbooks with a 40% effective tax rate.

The company is considering replacing an older manual printing press with a newer, computerized one. The old machine was purchased 10 years ago and had a total useful life of fifteen years. It originally cost $150,000 and was being depreciated by the simplified straight-line method at a rate of $10,000 per year. Since the old machine uses such outmoded technology, it can be sold today for only $35,000. The old machine required two operators who each earned $25,000 per year (salary expense). The old machine required $7,500 in maintenance expense each year. It produced a total of $10,000 per year of defective textbooks that could not be sold (defective product expense).

The new machine being considered will cost $195,000 and will require $1,000 shipping and $500 installation fees. In addition, Dash Corp. anticipates spending $3500 to modify the new machine for their special conditions. The new machine has a 5-year useful life and will be depreciated using MACRS with a 5-year investment class. At the end of five years of use, the new machine is expected to be sold for $65,000. The new machine requires only one operator who will earn $35,000 per year (salary expense). The new machine will require $7,500 in maintenance expense each year. The new machine will produce $12,000 per year of defective textbooks (defective product expense).

Since the new machine will operate so much faster than the old one, an additional $12,000 will be invested in inventory (net working capital). Also, an increase in sales revenue of $27,500 per year is expected.

MACRS Depreciation Schedule

Ownership Class of Investment

Year year 5-year 7-year 10-year

1 33% 20% 14% 10%

2 45 32 25 18

3 15 9 17 14

4 7 12 13 12

5 11 9 9

6 6 9 7

7 9 7

8 4 7

9 7

10 6

11 3

Given the information above, calculate the initial cash flow and the terminal cash flow for this project. Calculate ONLY the initial cash flow and the terminal cash flow. You DO NOT need to calculate the operating cash flows. They are shown below.

Operating CF (t=1-5) 1 2 3 4 5

Change in revenue +27500 +27500 +27500 +27500 +27500

Change in expenses -12000 -12000 -12000 -12000 -12000

Old depreciation +10000 +10000 +10000 +10000 +10000

New depreciation -40000 -64000 -38000 -24000 -22000

Change in deprec -30000 -54000 -28000 -14000 -12000

Change in EBT -14500 -38500 -12500 +1500 +3500

Change in tax +5800 15400 +5000 -600 -1400

Change in EAT -8700 -23100 -7500 +900 +2100

undo deprec +30000 +54000 +28000 +14000 +12000

Net CF +21300 +30900 +20500 +14900 +14100

Calculate ONLY the initial and terminal cash flows.