25300 Chapter Notes - Chapter 9: Capital Budgeting, Accounts Receivable
Tutorial questions 25300 FBF
Tutorial 7 – Capital Budgeting 2
1. Associated with a firm’s planned purchase of new $250,000 equipment is an immediate
decrease in inventory of $60,000. Should this figure be ignored in a capital budgeting analysis
of the new equipment? Explain. What about the $50,000 cash that the firm already has that
will reduce the equipment cost to $200,000?
2. A firm is contemplating the purchase of new automated plant costing $240,000 to replace an
existing machine that can be sold for $110,000 today. The existing machine (which can
continue to be operated for a further four years) was purchased one year ago for $100,000
and is being depreciated over its five-year life. For each year of its life the new plant’s
technology will allow the firm to reduce annual expenses by $80,000. Annual sales will remain
at the current level of $160,000 with the new machine. Although the new machine will only
be used for a four-year period, it has an eight-year depreciable life and an assumed disposal
value of zero in four years’ time. What are the relevant cash flows for each year of the new
machine’s life? Assume the company tax rate is 30%.
3. Anchor Ltd paid $15,000 last quarter for a feasibility study regarding the demand for motor-
boat replacement parts which would require the purchase of a new metal-shaping machine.
Today, they wish to conduct an analysis of the proposed project.
The machine costs $250,000 and will operate for five years. However, the tax rules allow the
machine to be depreciated to zero over a four-year life. The machine is expected to produce
sales of $135,000 annually for the five years. Anchor has already agreed to sell the machine in
five years’ time to an unrelated firm for $80,000.
The project will result in a $35,000 increase in accounts receivable and require an increase in
inventory levels by $20,000 to $95,000. Anchor has negotiated with its bank to borrow
$180,000 to help pay for the project. Loan repayments are $48,000 each year for five years.
If Anchor buys the machine they will be able to use some equipment that they currently own.
This is part of the driving force in the decision making as it enables the company to save
money in not buying additional new equipment. This equipment was bought for $120,000 six
years ago and could be sold today for $63,000. This equipment has been written off for tax
purposes and would be worthless in five years’ time.
If the company tax rate is 30% and the appropriate discount rate is 19.5%, should Anchor buy
the new machine?
(Answers: 1. No; Yes, 2. CF(0): -$139,000; CF(1 to 3): $59,000; CF(4): $95,000, 3. CF(0): -$349,100, CF(1 to 4):
+$113,250; CF(5): $205,500, Yes.)
Document Summary
Associated with a fir(cid:373)"s planned purchase of new ,000 equipment is an immediate decrease in inventory of ,000. A firm is contemplating the purchase of new automated plant costing ,000 to replace an existing machine that can be sold for ,000 today. The existing machine (which can continue to be operated for a further four years) was purchased one year ago for ,000 and is being depreciated over its five-year life. For each year of its life the (cid:374)e(cid:449) pla(cid:374)t"s technology will allow the firm to reduce annual expenses by ,000. Annual sales will remain at the current level of ,000 with the new machine. Anchor ltd paid ,000 last quarter for a feasibility study regarding the demand for motor- boat replacement parts which would require the purchase of a new metal-shaping machine. Today, they wish to conduct an analysis of the proposed project. The machine costs ,000 and will operate for five years.
