DEF company is considering purchasing a new rubber extrusion line that produces rolling bands, flanks, and other products used in the process of tire manufacturing. This line will replace the existing one, which was purchased 4 years ago for $200,000, at an installation cost of $50,000; it was depreciated under straight-line amortization, and with 4 years of usable life remaining. The new line is more expensive (it costs $800,000 and does not have any additional installation costs), but at the same time requires an increase in accounts receivable by $800,000, inventories by $200,000 and accounts payable by $500,000. DEF company can sell the existing line for $150,000 without incurring any additional costs. In addition, suppose the new rubber extrusion line is amortized for 5 years, with the following methods: 20% in year 1, 30% in year 2, 15% in year 3, 10% in year 4 and 5% in year 5. At the end of 5 years, the existing line would have a market value of zero; the new line would be sold to net $100,000 after removal and clean-up costs and before tax. The firm is subject to 24% tax rate. The following table shows the estimated eamings before interest, tax, depreciation, and amortization over the 5 years for both the new and the existing line. Eamings before interest, taxes, depreciation, and amortization Existing line $280,000 Year Alternative new line $250,000 1 | 250,000 250,000 3 250,000 220,000 4 250,000 180,000 250,000 150,000
DEF company is considering purchasing a new rubber extrusion line that produces rolling bands, flanks, and other products used in the process of tire manufacturing. This line will replace the existing one, which was purchased 4 years ago for $200,000, at an installation cost of $50,000; it was depreciated under straight-line amortization, and with 4 years of usable life remaining. The new line is more expensive (it costs $800,000 and does not have any additional installation costs), but at the same time requires an increase in accounts receivable by $800,000, inventories by $200,000 and accounts payable by $500,000. DEF company can sell the existing line for $150,000 without incurring any additional costs. In addition, suppose the new rubber extrusion line is amortized for 5 years, with the following methods: 20% in year 1, 30% in year 2, 15% in year 3, 10% in year 4 and 5% in year 5. At the end of 5 years, the existing line would have a market value of zero; the new line would be sold to net $100,000 after removal and clean-up costs and before tax. The firm is subject to 24% tax rate. The following table shows the estimated eamings before interest, tax, depreciation, and amortization over the 5 years for both the new and the existing line. Eamings before interest, taxes, depreciation, and amortization Existing line $280,000 Year Alternative new line $250,000 1 | 250,000 250,000 3 250,000 220,000 4 250,000 180,000 250,000 150,000
Chapter9: Capital Budgeting And Cash Flow Analysis
Section: Chapter Questions
Problem 10P
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Transcribed Image Text:DEF company is considering purchasing a new rubber extrusion line that produces
rolling bands, flanks, and other products used in the process of tire manufacturing. This
line will replace the existing one, which was purchased 4 years ago for $200,000, at an
installation cost of $50,000; it was depreciated under straight-line anmortization, and
with 4 years ofusable life remaining. The new line is more expensive (it costs $800,000
and does not have any additional installation costs), but at the same time requires an
increase in accounts receivable by $800,000, inventories by $200,000 and accounts
payable by $500,000. DEF company can sell the existing line for $150,000 without
incurring any additional costs.
In addition, suppose the new rubber extrusion line is amortized for 5 years, with the
following methods: 20% in year 1, 30% in year 2, 15% in year 3, 10% in year 4 and
5% in year 5.
At the end of 5 years, the existing line would have a market value of zero; the new line
would be sold to net $100,000 after removal and clean-up costs and before tax. The
firm is subject to 24% tax rate. The following table shows the estimated eamings before
interest, tax, depreciation, and amortization over the 5 years for both the new and the
existing line.
Eamings before interest, taxes, depreciation, and amortization
Existing line
$280,000
Year
Alternative new line
1
$250,000
2
250,000
250,000
3.
250,000
220,000
4
250,000
180,000
250,000
150,000
Transcribed Image Text:i.
Compute the initial investment associated with the alternative line.
i.
Compute the incremental operating cash flows associated with the alternative line
replacement.
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