Question

DataPoint Engineering is considering the purchase of a new piece of equipment for $310,000. It has an eight-year midpoint of its asset depreciation range (ADR). It will require an additional initial investment of $130,000 in nondepreciable working capital. Fifty-two thousand dollars of this investment will be recovered after the sixth year and will provide additional cash flow for that year. Income before depreciation and taxes for the next six are shown in the following table. Use Table 12–11, Table 12–12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. Year 1 au WN Amount $206,000 174,000 144,000 129,000 102,000 92,000 The tax rate is 25 percent. The cost of capital must be computed based on the following: Cost (aftertax) 8.30% 12.40 17.00 Weights 40% Debt Preferred stock Common equity (retained earnings) 10 Ke 50

Answer 1

a.) Annual depreciation is calculate as: 310000/8 = 38750

For next six year it is calculated as follow:(All values are in $)

Year	Depreciation base	Percentage Depreciation	Annual Depreciation
1	310000	12.5%	38750
2	271250	14.28%	38750
3	232500	16.67%	38750
4	193750	20%	38750
5	155000	25%	38750
6	116250	33.33%	38750

Note: 1. Depreciation base for 2nd year is calculated (310000-38750=271250) and vice versa.

2. Percentage Depreciation is calculated as: (38750/310000=12.5%) for 1st year and vice versa.

b.) The annual cash flow for each year are as follow

Year	Calculation	Cash flow
1	206000-51500	154500
2	174000-43500	130500
3	144000-36000	108000
4	129000-32250	96750
5	102000-25500	76500
6	92000-23000+130000	199000

Formula for calculating cash flow: EBDAT-Tax income (206000-(206000*0.25))

c.) Weighted average cost of capital:(0.50*0.17+0.10*0.1240+0.083*0.40*(1-0.25)) = 12.23%

d 1.) Net present value:

Year	Cash flow	Working capital	PV at 12.23%	PV
1	154500		0.891	137659.5
2	130500		0.793	103486.5
3	108000		0.707	76356
4	96750		0.630	60952.5
5	76500		0.561	42916.5
6	92000	130000	0.500	99500
Total Present Value				520871

Net present value: 520871-310000 = $210871.

d 2 .) Yes. DataPoint should purchase the new equipment.