Dublin Chips is a manufacturer of prototype chips based in​Buffalo, New York.
Next​ year, in 2018​, Dublin Chips expects to deliver 615prototype chips at an average price of $95,000. Dublin ​Chips'marketing vice president forecasts growth of 65 prototype chips peryear through 2024.
That​ is, demand will be 615 in 2018​, 680 in 2019​, 745 in2020​, and so on. The plant cannot produce more than 585 prototypechips annually. To meet future​ demand, Dublin Chips must eithermodernize the plant or replace it. The old equipment is fullydepreciated and can be sold for $4,200,000 if the plant isreplaced. If the plant is​ modernized, the costs to modernize itare to be capitalized and depreciated over the useful life of theupdated plant. The old equipment is retained as part of themodernize alternative.
The following data on the two options are​ available:
| Modernize | | Replace |
Initial investment in 2018 | $35,300,000 | | $66,300,000 |
Terminal disposal value in 2024 | $7,500,000 | | $16,000,000 |
Useful life | 7 years | | 7 years |
Total annual cash operating cost per prototype chip | $78,500 | | $66,000 |
Dublin Chips uses​ straight-line depreciation, assuming zeroterminal disposal value. For​ simplicity, we assume no change inprices or costs in future years. The investment will be made at thebeginning of 2018​, and all transactions thereafter occur on thelast day of the year. Dublin ​Chips' required rate of return is14​%. There is no difference between the modernize and replacealternatives in terms of required working capital. Dublin Chipspays a 35​% tax rate on all income. Proceeds from sales ofequipment above book value are taxed at the same 35​% rate.
1. | Calculate the​ after-tax cash inflows and outflows of themodernize and replace alternatives over the 2018
-2024 period. |
2. | Calculate the net present value of the modernize and replacealternatives. |
3. | Suppose Dublin Chips is planning to build several more plants.It wants to have the most advantageous tax position possible.DublinChips has been approached by​ Spain, Malaysia, and Australia toconstruct plants in their countries. Briefly describe inqualitative terms the income tax features that would beadvantageous to Dublin
Chips. |
​Let's begin with the modernize alternative. Start by computingthe present value of the​after-tax cash flows from​ operations,then calculate the present value of the​ after-tax cash savingsfrom depreciation and the terminal disposal​ value, and​ finally,determine the total net present value​ (NPV) of the investment forthe modernize alternative.
| | | Net Cash | Present Value |
| PV factor | | Inflow | of Cash Flows |
Net initial investment | | | | |
After-tax cash flows from operations: | | | | |
Dec 31, 2018 | | x | | = | |
Dec 31, 2019 | | x | Â Â | = | |
Dec 31, 2020 | | x | | = | |
Dec 31, 2021 | | x | | = | |
Dec 31, 2022 | | x | | = | |
Dec 31, 2023 | | x | | = | |
Dec 31, 2024 | | x | | = | |
