Book: Fundamentals ofFinancial

ofFinancial Management,
Management, James C. Van HorneJohn
HorneJohn M. Wachowicz, Jr., 13th
13th Edition, 2008

2. The Fresno Finial Fabricating Works is considering automating its existing finial casting
and assembly department. The plant manager, Mel Content, has accumulated the
following information for you:
a. The automation proposal would result in reduced labor costs of $150,000 per year.
b. The cost of defects is expected to remain at $5,000 even if the new automation proposal
is accepted.
c. New equipment costing $500,000 would need to be purchased. For financial reporting
purposes, the equipment will be depreciated on a straight-line basis over its useful fouryear
life. For tax purposes, however, the equipment falls into the three-year property
class and will be depreciated using the MACRS depreciation percentages. The estimated
final salvage value of the new equipment is $50,000.
d. Annual maintenance costs will increase from $2,000 to $8,000 if the new equipment is
purchased. e. The company is subject to a marginal tax rate of 40 percent. This Model is prepared by Rajib Dahal. If you need
What are the relevant incremental cash inflows over the proposal’s useful life, and what excelsheet calculation, please contact me at my email at
is the incremental cash outflow at time 0?? rajib.dahal@nu.edu.kz/rajib.dahal@gmail.com
Capital Budgeting and Estimating Cash Flows - PART V - Chapter 12, Self-Correction Problems at Page No. 319
Assumptions
Annual reduced labour cost 150,000.00 Depreciation Schedule for three year property class (for tax purpose)
Annual cost of defect(unchanged at) 5,000.00 Year 1 33.33%
Capex for new machine 500,000.00 Year 2 44.45%
Annual Depreciation as per books 125,000.00 Year 3 14.81%
Tax Rate 0.40 Year 4 7.41%
Net increase in Annual maintenance cost 6,000.00
Salvage Value of new machine 50,000.00
Discounted Cash Flow Year 0 Year 1 Year 2 Year 3 Year 4
Initial Capex Investment 500000.00
Cash savings from new machine 150,000.00 150,000.00 150,000.00 150,000.00
D&A(As Per Books) 125,000.00 125,000.00 125,000.00 125,000.00
D&A(for tax purpose) 166,650.00 222,250.00 74,050.00 37,050.00
Salvage Value of new machine 50,000.00
Gain from Salvage Value 50,000.00
Net increase in Annual maintenance cost 6,000.00 6,000.00 6,000.00 6,000.00
Cashflow before taxation -22650.00 -78250.00 69950.00 156950.00
Taxation -9060.00 -31300.00 27980.00 62780.00
Cash flows after taxation -13590.00 -46950.00 41970.00 94170.00
Add: D&A (for tax purpose) 166650.00 222250.00 74050.00 37050.00
Transaction Cash flows 500,000.00 153,060.00 175,300.00 116,020.00 131,220.00
Total (Without discounting) 1,075,600.00