Question

Universal Electronics is considering the purchase of manufacturing equipment with a 10-year midpoint in its asset depreciation range (ADR). Carefully refer to Table 12–11 to determine in what depreciation category the asset falls. (Hint: It is not 10 years.) The asset will cost $255,000, and it will produce earnings before depreciation and taxes of $85,000 per year for three years, and then $40,000 a year for seven more years. The firm has a tax rate of 25 percent. Assume the cost of capital is 14 percent. In doing your analysis, if you have years in which there is no depreciation, merely enter a zero for depreciation. Use Table 12–12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

a. Calculate the net present value. (Do not round intermediate calculations and round your answer to 2 decimal places.)

b. Based on the net present value, should Universal Electronics purchase the asset?

Appendix B Present value of $1, PVF PV = FV ((1+"] Period 9% 12% 2 1% 0.990 0.980 0.971 0.961 0.951 5% 0.952 0.907 0.864 0.823 0.784 0.917 0.842 0.772 0.708 3 3% 0.971 0.943 0.915 0.888 0.863 0.837 0.813 0.789 0.766 0.744 8% 0.926 0.857 0.794 0.735 0.681 0.630 10% 0.909 0.826 0.751 0.683 0.621 0.564 4 5 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.650 6 0.942 0.746 0.596 0.547 0.933 0.711 0.583 0.513 7 8 0.502 0.467 0.404 10 11 0.722 0.460 0.422 0.388 0.356 2% 0.980 0.961 0.942 0.924 0.906 0.888 0.871 0.853 0.837 0.820 0.804 0.788 0.773 0.758 0.743 0.728 0.714 0.700 0.686 0.673 0.610 0.552 0.453 0.372 12 4% 0.962 0.925 0.889 0.855 0.822 0.790 0.760 0.731 0.703 0.676 0.650 0.625 0.601 0.577 0.555 0.534 0.513 0.494 0.475 0.456 0.375 0.308 0.208 0.141 Percent 6% 7% 0.943 0.935 0.890 0.873 0.840 0.816 0.792 0.763 0.747 0.713 0.705 0.666 0.665 0.623 0.627 0.582 0.592 0.544 0.558 0.508 0.527 0.475 0.497 0.444 0.469 0.415 0.442 0.388 0.417 0.362 0.394 0.339 0.371 0.317 0.350 0.296 0.331 0.277 0.312 0.258 0.233 0.184 0.174 0.131 0.097 0.067 0.054 0.034 0.701 0.326 13 14 0.923 0.914 0.905 0.896 0.887 0.879 0.870 0.861 0.853 0.844 0.836 0.828 0.820 0.780 0.742 0.672 0.608 0.299 11% 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352 0.317 0.286 0.258 0.232 0.209 0.188 0.170 0.153 0.138 0.124 0.074 0.044 0.015 0.005 15 0.275 16 0.677 0.645 0.614 0.585 0.557 0.530 0.505 0.481 0.458 0.436 0.416 0.396 0.377 0.295 0.231 0.142 0.087 0.540 0.500 0.463 0.429 0.397 0.368 0.340 0.315 0.292 0.270 0.250 0.232 0.215 0.146 0.099 0.046 0.021 0.681 0.661 0.642 0.623 0.605 0.587 0.570 0.554 0.478 0.412 0.307 0.228 0.424 0.386 0.350 0.319 0.290 0.263 0.239 0.218 0.198 0.180 0.164 0.149 0.092 0.057 0.022 0.009 17 18 0.361 0.322 0.287 0.257 0.229 0.205 0.183 0.163 0.146 0.130 0.116 0.104 0.059 0.033 0.011 0.003 0.252 0.231 0.212 0.194 0.178 0.116 0.075 0.032 0.013 19 20 25 30 40 50

Answer 1

Year	0	1	2	3	4	5	6	7	8	9	10
cost of equipment	-255000
EBIT		85000	85000	85000	85000	85000	85000	85000	85000	85000	85000
Less Depreciation		36465	62475	44625	31875	22695	22695	22695	11475	0	0
operating profit		48535	22525	40375	53125	62305	62305	62305	73525	85000	85000
less tax-25%		12133.75	5631.25	10093.75	13281.25	15576.25	15576.25	15576.25	18381.25	21250	21250
after tax profit		36401.25	16893.75	30281.25	39843.75	46728.75	46728.75	46728.75	55143.75	63750	63750
add depreciation		36465	62475	44625	31875	22695	22695	22695	11475	0	0
net operating cash flow	-255000	72866.25	79368.75	74906.25	71718.75	69423.75	69423.75	69423.75	66618.75	63750	63750
Present value factor at 14% =1/(1+r)^n r =14%	1	0.877193	0.769468	0.674972	0.59208	0.519369	0.455587	0.399637	0.350559	0.307508	0.269744
Present value of net operating cash flow = net operating cash flow*present value factor	-255000	63917.76	61071.68	50559.59	42463.26	36056.52	31628.53	27744.32	23353.81	19603.63	17196.17
Net present value = sum of present value of net operating cash flow	118595.26
Yes equipment should be purchased as it results in positive NPV
Year	1	2	3	4	5	6	7	8
cost of equipment	255000	255000	255000	255000	255000	255000	255000	255000
MACRS GDS rate	0.143	0.245	0.175	0.125	0.089	0.089	0.089	0.045
Annual Depreciation = cost of equipment*MACRS rate	36465	62475	44625	31875	22695	22695	22695	11475