XTC Corp. is considering the replacement of equipment used to produce zips. Last year, XTC produced...

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XTC Corp. is considering the replacement of equipment used toproduce zips. Last year, XTC produced and sold 100,000 zips at aunit price of $32. Operating expenses (excluding depreciation) withthe old equipment are 30% of sales. XTC expects demand for zips toincrease 10% per year over the next five years, but XTC currentlyhas the capacity to produce only 112,800 zips per year with theexisting equipment. The new equipment would increase capacity to155,500 zips per year and would also reduce operating expenses to28% of sales for all zips produced over the next five years. Thesales price for zips is expected to increase at the expectedinflation rate of 3% per year over the five-year life of theproject.
The existing equipment was purchased five years at a price of $1million. It is being depreciated using 5-year MACRS. It could besold now for $20,000. The new equipment is expected to cost $2million, including installation. It is being depreciated using5-year MACRS and is expected to have zero salvage value five yearsfrom now. The $2 million cost of the new equipment will be financedwith equal amounts of debt and equity. The debt will carry anannual interest rate of 6%; thus, the project will cause anincrease in annual interest of $60,000 for XTC, computed as 0.06 x$1 million.
No increases in net operating working capital, NOWC, areexpected for the project. However, the corporate accountingdepartment has informed the division that produces zips that itwill allocate an additional $12,650 of existing fixed overhead eachyear to the division if this project is accepted.
Assume the cost of capital for the project is 8%. Also assumethat XTC has a 30% marginal tax rate. Compute the incremental cashflows after tax (CFAT) over the five-year life of the project.Compute the NPV and IRR and recommend whether the project should beaccepted or rejected.
Note:
• Round all cash flows (except the price of zips) to the nearestdollar.
• All net cash inflows should be shown as positive numbers, andall net cash outflows should be shown as negative numbers inparentheses.
• Organize your work neatly.
• The more work you show, the greater the chance to earn partialcredit.

Answer & Explanation Solved by verified expert

4.3 Ratings (861 Votes)

Calculation of tax saving on machine WDVsalvage valuetaxrate 0057610000002000003 11280 Initial cost of machine 2000000 Net cash outflow 200000011280 1988720 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 MACRS 02 032 0192 01152 01152 00576 Calculationof incremental cashflow Year 0 1 2 3 4 5 a Units sales old machine 110000 112800 112800 112800 112800 b Units sales new machine 110000 121000 See Answer

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Transcribed Image Text

XTC Corp. is considering the replacement of equipment used toproduce zips. Last year, XTC produced and sold 100,000 zips at aunit price of $32. Operating expenses (excluding depreciation) withthe old equipment are 30% of sales. XTC expects demand for zips toincrease 10% per year over the next five years, but XTC currentlyhas the capacity to produce only 112,800 zips per year with theexisting equipment. The new equipment would increase capacity to155,500 zips per year and would also reduce operating expenses to28% of sales for all zips produced over the next five years. Thesales price for zips is expected to increase at the expectedinflation rate of 3% per year over the five-year life of theproject.The existing equipment was purchased five years at a price of $1million. It is being depreciated using 5-year MACRS. It could besold now for $20,000. The new equipment is expected to cost $2million, including installation. It is being depreciated using5-year MACRS and is expected to have zero salvage value five yearsfrom now. The $2 million cost of the new equipment will be financedwith equal amounts of debt and equity. The debt will carry anannual interest rate of 6%; thus, the project will cause anincrease in annual interest of $60,000 for XTC, computed as 0.06 x$1 million.No increases in net operating working capital, NOWC, areexpected for the project. However, the corporate accountingdepartment has informed the division that produces zips that itwill allocate an additional $12,650 of existing fixed overhead eachyear to the division if this project is accepted.Assume the cost of capital for the project is 8%. Also assumethat XTC has a 30% marginal tax rate. Compute the incremental cashflows after tax (CFAT) over the five-year life of the project.Compute the NPV and IRR and recommend whether the project should beaccepted or rejected.Note:• Round all cash flows (except the price of zips) to the nearestdollar.• All net cash inflows should be shown as positive numbers, andall net cash outflows should be shown as negative numbers inparentheses.• Organize your work neatly.• The more work you show, the greater the chance to earn partialcredit.