Capital Budgeting - Exercise 1 – Spring 2002            Name___________________________

AT LEAST ONE PART (A OR B) MUST BE DONE ON A SPREAD SHEET

A.) Degnan Dance Company, Inc., a manufacturer of dance and exercise apparel, is considering replacing an existing piece of equipment with a more sophisticated machine.  The following information is given.  (50%)

                                                                          Facts

                                                                          ‑‑‑‑‑

         Existing Machine                              Proposed Machine

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Cost = $200,000                                              Cost = $250,000

Purchased 2 years ago                                      Installation = $20,000

Depreciation using MACRS                              Depreciation‑‑the MACRS   a 5‑year recover schedule 5‑year recovery schedule                    will be used.

Current market value = $205,000

Five year usable life remaining                           Five year usable life expected

Can be sold in 5 years for $80,000                   Can be sold in 5 years for $110,000.

                                                Earnings Before Depreciation and Taxes

                                                  ‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑‑

Existing Machine                       Proposed Machine

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Year     1          $260,000           Year   1         $290,000

                        2            260,000                     2           290,000

                        3            240,000                     3           290,000

                        4            230,000                     4           290,000

                        5            200,000                     5           290,000

The firm pays 40 percent taxes on ordinary income and capital gains and the firms required return is 15%.

MACRS  5 yr

1                    20%

2                    32

3                    19

4                    12

5                    12

6                    5

1.              Calculate the book value of the existing asset being considered for replacement at time 0, today.

2.              Calculate the tax effect from the sale of the existing asset at time 0.

3.              Calculate the initial investment required for the new asset.

4.              Summarize the incremental after‑tax cash flow (relevant cash flows) for years t=0 through t=5.

5.              Calculate the terminal cash flow.

6.              Calculate the payback period, the NPV and the IRR of the replacement project.

7.              Should the machine be replaced? And Why

B)Integrative Case 3 – Chapter 10(except for part d)(50%)

Bridgewater State College

Department of Accounting and Finance

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