Metro Labs Starter by HC120915172448

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									Metro Imaging Labs, Inc. Capital Budgeting Example
CAPITAL BUDGETING REPLACEMENT DECISION: CASH FLOWS
Net Investment:                                                        MetroLabsStarter.xls
Metro Imaging Labs, Inc. provides imaging and lab testing services for the medical
community. They are considering replacing some automated test equipment which
was purchased several years ago. The test equipment which was purchased for
$600,000 currently has a book value of $250,000. The new, more efficient test
equipment will cost $1,000,000 and will require an additional $50,000 for delivery
and installation. The new test equipment will also require the firm to increase its
investment in working capital by $10,000. The new test equipment will be
depreciated in accordance with the 5-year MACRS schedule.The company
expects to sell the old test equipment for $300,000 and is in the 40% marginal tax
rate (federal + state + local). Determine the firm's net investment in the
new test equipment.


SOLUTION:
         Step 1:             XXXXXX       asset cost
                             XXXXXX       delivery and installation
            Step 2:          XXXXXX       increase in working capital
            Step 3:          XXXXXX       proceeds from the sale of old asset
            Step 4:          Formula!!!   tax on gain from old asset sale1
                             Formula!!!   Net Investment


         1. Formula!!! sale price                        Formula!!! gain on sale
              250,000 book value                          XXXXXX ordinary tax rate
            Formula!!! gain on sale                      Formula!!! tax on gain


Net Cash Flows:
If Metro purchases the new test equipment, revenues are expected to
increase by $200,000 (due to increased capacity) and cash operating
expenses are expected to decrease by $20,000. After five years the
test equipment is expected to be sold for $70,000. Assume that the original
test equipment was depreciated $50,000 per year. Compute the project's net
cash flows.
SOLUTION:
Depreciable base = installed cost =                      Formula!!!
Depreciation Schedule:
                             Depreciation Depreciation      Year End
                      Year          Rate      Amount      Book Value
                        1      20.00%     Formula!!!     Formula!!!
                        2      32.00%     Formula!!!     Formula!!!
                        3      19.20%     Formula!!!     Formula!!!
                        4      11.52%     Formula!!!     Formula!!!
                        5      11.52%     Formula!!!     Formula!!!
                        6       5.76%     Formula!!!     Formula!!!
                              100.00%     Formula!!!
Aftertax Salvage Value of New Equipment (ATSV):
            At the end of its economic life the new equipment will be
            sold for more than its book value resulting in the
            recapture of depreciation.
                            Book value in year 5 Formula!!!
                             Salvage value (SV)       70,000
                               Overdepreciation Formula!!!
                                     Tax rate (T) Formula!!!
                              Tax increase (Tax) Formula!!!
                                           ATSV Formula!!! <-- SV - Tax
Incremental Operating Cash Flows (OCF's):
                              Incremental                                 Incremental        OCF =
                Incremental    Operating           New           Old      Depreciation      (R-O-D)
      Year     Revenues (R)    Costs (O)        Depreciation Depreciation     (D)          (1-T) + D
         1        200,000        -20,000        Formula!!!        50,000   Formula!!!     Formula!!!
         2        200,000        -20,000        Formula!!!        50,000   Formula!!!     Formula!!!
         3        200,000        -20,000        Formula!!!        50,000   Formula!!!     Formula!!!
         4        200,000        -20,000        Formula!!!        50,000   Formula!!!     Formula!!!
         5        200,000        -20,000        Formula!!!        50,000   Formula!!!     Formula!!!
Net Cash Flows (NCF's):             Opportunity Cost of Capital =                10%
                                                                              Discount
       Year          ATSV      WC Return               OCF           NCF         factor      PV (NCF)
          0         negative of Initial Investment --> Formula!!!              1.0000     Formula!!!
          1                              Formula!!!             0              0.9091     Formula!!!
          2                              Formula!!!             0              0.8264     Formula!!!
          3                              Formula!!!             0              0.7513     Formula!!!
          4                              Formula!!!             0              0.6830     Formula!!!
          5 Formula!!! XXXXXX Formula!!!                        0              0.6209     Formula!!!
                                                                                 NPV Formula!!!
    Discount
        Rate     Formula!!!                                                       IRR Formula!!!
       0%      Formula!!!
       1%      Formula!!!                                         NPV Profile
       2%      Formula!!!
       3%      Formula!!!
                                            1
       4%      Formula!!!
       5%      Formula!!!                   1
       6%      Formula!!!                   1
       7%      Formula!!!
                                            1
       8%      Formula!!!
       9%      Formula!!!                   1
      10%      Formula!!!
                                            1
      11%      Formula!!!
      12%      Formula!!!                   0
      13%      Formula!!!                   0
      14%      Formula!!!
      15%      Formula!!!                   0
      16%      Formula!!!                   0
      17%      Formula!!!
                                            0
      18%      Formula!!!
      19%      Formula!!!                   0%               5%            10%              15%         20%

								
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