Two years ago, a steel company installed a blast furnace for a total of $ 19,200....

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Two years ago, a steel company installed a blast furnace for atotal of $ 19,200. Due to a technological change, another type ofmore efficient furnace can be purchased for $ 208,000 with asavings of $ 38,000 per year of fuel compared to the currentfrontier. Maintenance costs are estimated at $ 8,000 and $ 4800 peryear for the new furnace and the current furnace, respectively. Foraccounting purposes, taxes and depreciation charges are calculatedby the straight-line method, with residual values ??null and lifeof 10 and 12 years for new and current furnaces, respectively.Other costs (insurance, etc.) will remain unchanged regardless ofthe type of furnace used. Both equipment, once installed, only hasvalue as scrap, with the cost of removal of value approximatelyequal. The interest rate, after taxes deducted, is 12% per year.Consider for the analysis a tax rate of 50% on taxable income andthat once you have opted for an equipment, it will be held for 10years.

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4.4 Ratings (697 Votes)

	Incremental cash flow /(cost)
savings in Fuel	38000
less:Incremental maintenance cost	(3200) [8000-4800]
Incremental depreciation	(19200) [20800-1600]
Incremental income before tax	15600
less:tax [15600*.50]	(7800)
Income after tax	7800
add:depreciation (non cash)	19200
Net incremental cash flow	27000

Present value of annual incremental cash flow =PVA12%,10* Net incremental cash flow

= 5.65022* 27000

= $ 152555.94

NPV = present value -initial cost

= 152,555.94 - 208000

= - 55,444.06

**since NPV of buying new Furnace is negative ,it should not be purchased.

WORKING:

**Depreciation on old furnace = 19200/12=1600 per year

Depreciation on new Furnace = 208000/10= 20800

**Find present value annuity factor from present value annuity table (ordinary) at 12%,10 or using financial calculator.

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Transcribed Image Text

Two years ago, a steel company installed a blast furnace for atotal of $ 19,200. Due to a technological change, another type ofmore efficient furnace can be purchased for $ 208,000 with asavings of $ 38,000 per year of fuel compared to the currentfrontier. Maintenance costs are estimated at $ 8,000 and $ 4800 peryear for the new furnace and the current furnace, respectively. Foraccounting purposes, taxes and depreciation charges are calculatedby the straight-line method, with residual values ??null and lifeof 10 and 12 years for new and current furnaces, respectively.Other costs (insurance, etc.) will remain unchanged regardless ofthe type of furnace used. Both equipment, once installed, only hasvalue as scrap, with the cost of removal of value approximatelyequal. The interest rate, after taxes deducted, is 12% per year.Consider for the analysis a tax rate of 50% on taxable income andthat once you have opted for an equipment, it will be held for 10years.