Scientific Frontiers Corporation manufactures scientific equipment for use in elementary schools. In December of 20xO the company's management is considering the acquisition of robotic equipment, which would radically change its manufacturing process. The controller has collected the following data pertinent to the decision. 1. The robotic equipment would cost $1,400,000, to be paid in December of 20x0. The equipment's useful life is projected to be eight years. The equipment is in the MACRS 5-year property class. The company will use the MACRS accelerated depreciation schedule. 2. The robotic equipment requires software, which will be developed over a two-year period in 20x1 and 20x2. Each software expenditure, which will amount to $27,000 per year, will be expensed during the year incurred. 3. A computer systems operator will be hired immediately to oversee the operation of the new robotic equipment. The computer expert's annual salary will be $54,000. Fringe benefits will cost $28,000 annually. 4. Maintenance technicians will be needed. The total cost of their wages and fringe benefits will be $165,000 per year. 5. The changeover of the manufacturing line will cost $98,000, to be expensed in 20x1. 6. Several employees will need retraining to operate the new robotic equipment. The training costs are projected as follows: 20x1 $37,000 20x2 27,000 20x3 18,000 7. An inventory of spare parts for the robotic equipment will be purchased immediately at a cost of $68,000. This investment in working capital will be maintained throughout the eight-year life of the equipment. At the end of 20x8, the parts will be sold for $68,000. 8. The robotic equipment's salvage value at the end of 20x8 is projected to be $70,000. It will be fully depreciated at that time. 9. Aside from the costs specifically mentioned above, management expects the robotic equipment to save $560,000 per year in manufacturing costs. 10. Switching to the robotic equipment will enable Scientific Frontiers Corporation to sell some of its manufacturing machinery over the next two years. The following sales schedule is projected. Acquisition Cost of Equipment Sold 20x1 $ 190,000 20x2 345,000 Accumulated Depreciation at Time of Sale $ 116,000 231,000 Sales Proceeds $ 36,000 172,000 11. Scientific Frontiers Corporation's tax rate is 30 percent. 12. The company's after-tax hurdle rate is 10 percent. MACRS Property Class 5-year 7-year Year 3-year 10-year 20.00% 32.00 ...................................................... .. ..... Exhibit 169 Selected MACRS Depreciation Percentages as Computed by the IRS (incorporates half- year convention; also incorpo- rates recent modifications in the tax laws) 33.33% 44.45 14.81* 7.41 ..... 14.29% 24.49 17.49 12.49 10.00% 18.00 14.40 11.52 19.20 11.52* 8.93* 11.52 5.76 9.22 7.37 8.92 8.93 4.46 6.55* 6.55 6.56 6.55 3.28 10 ............... 11 ................ * Denotes the year during which the depreciation method switches to the straight-line method. Source: IRS Publication 946, entitled "How to Depreciate Property." Required: Prepare a year-by-year columnar schedule including all of the after-tax cash flows associated with the robotic-equipment decision. Assume that each cash flow will occur at year-end. (Negative amounts should be indicated by a minus sign.) 20x0 20x1 2 0x2 20x3 20x4 20x5 20x6 20x7 Type of Cash Flow 1. Acquisition cost and depreciation tax shield 2. Software development 3. Computer expert's salary and fringe benefits 4. Maintenance technicians' wages and fringe benefits 5. Changeover of line 6. Employee training 7. Investment in working capital (spare parts) 8. Salvage value of equipment Tax effect of gain on sale 9. Savings on manufacturing costs 10. Disposal of equipment: Sales proceeds Tax effect of gain or loss Total after-tax cash flow
