P7.2 (LO 2, 3), AN As a supervisor in Wealth Health Services, you oversee the investment activity of a number of clients as well as train interns and new staff in the company. Cole, a college junior, is in just the second week of his 12-week internship. He is helping a client evaluate an asset replacement decision while following a similar example from a different client. He presents the asset replacement information, along with his analysis to you, as follows. Original cost of existing asset Market value of existing asset today Book value of existing asset today $ 80,000 $ 5,000 $ 5,000 New replacement asset cost $150,000 New replacement asset useful life (years) 10 $ 5,000 $ 25,000 Estimated salvage value of new replacement asset at end of useful life Estimated additional operating cash inflows from new replacement asset Minimum required return 10% Effective tax rate 28% Cole's Analysis $ Proceeds from sale of existing asset Cost of new replacement asset 5,000 $ (150,000) Present value of new asset's operating cash flows $25,000 ordinary annuity, n = 10, i = 10% $25,000 x 6.14457 $153,614.25 $ 8,614.25 Total NPV of replacement Based on his analysis, Cole suggests moving forward with this asset replacement.
P7.2 (LO 2, 3), AN As a supervisor in Wealth Health Services, you oversee the investment activity of a number of clients as well as train interns and new staff in the company. Cole, a college junior, is in just the second week of his 12-week internship. He is helping a client evaluate an asset replacement decision while following a similar example from a different client. He presents the asset replacement information, along with his analysis to you, as follows. Original cost of existing asset Market value of existing asset today Book value of existing asset today $ 80,000 $ 5,000 $ 5,000 New replacement asset cost $150,000 New replacement asset useful life (years) 10 $ 5,000 $ 25,000 Estimated salvage value of new replacement asset at end of useful life Estimated additional operating cash inflows from new replacement asset Minimum required return 10% Effective tax rate 28% Cole's Analysis $ Proceeds from sale of existing asset Cost of new replacement asset 5,000 $ (150,000) Present value of new asset's operating cash flows $25,000 ordinary annuity, n = 10, i = 10% $25,000 x 6.14457 $153,614.25 $ 8,614.25 Total NPV of replacement Based on his analysis, Cole suggests moving forward with this asset replacement.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Question
Transcribed Image Text:P7.2 (LO 2, 3), AN As a supervisor in Wealth Health Services, you oversee the investment activity of a number of
clients as well as train interns and new staff in the company. Cole, a college junior, is in just the second week of his
12-week internship. He is helping a client evaluate an asset replacement decision while following a similar example
from a different client. He presents the asset replacement information, along with his analysis to you, as follows.
Original cost of existing asset
Market value of existing asset today
Book value of existing asset today
$ 80,000
$ 5,000
$ 5,000
New replacement asset cost
$150,000
New replacement asset useful life (years)
Estimated salvage value of new replacement asset at end of useful life
Estimated additional operating cash inflows from new replacement asset
10
$ 5,000
$ 25,000
Minimum required return
10%
Effective tax rate
28%
Cole's Analysis
Proceeds from sale of existing asset
Cost of new replacement asset
$ 5,000
$ (150,000)
Present value of new asset's operating cash flows
$25,000 ordinary annuity, n = 10, i = 10%
$25,000 x 6.14457
$153,614.25
$ 8,614.25
Total NPV of replacement
Based on his analysis, Cole suggests moving forward with this asset replacement.
Transcribed Image Text:Required
a. After looking at the original information, you make a quick judgment about the viability of the project.
However; your quick conclusion is different from what Cole's quantitative analysis shows. Did Cole get off
track somewhere in his analysis, or was your quick judgment incorrect? If there is an error (or multiple
errors) in the analysis, specify where. Determine the correct NPV of the investment (assume any gain/loss
on sale of an asset is taxed at the same rate as operating income).
b. Cole neglected to include a payback period estimate for this investment, which is standard procedure in
your company for these types of analyses. Determine the simple payback period (before-tax) and compare
it to the company's standard payback period of 5 years or less.
c. Are your conclusions in parts (a) and (b) consistent? Explain why or why not. Additionally, specify at least
two changes that, if realized, would improve the capital budgeting metrics for this project just considered.
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