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25-01-2019

# Re-equipment Problem

## Part A

1. Should the company buy the proposed equipment?
 Question 1 Year Cash Flows 0 -1,00,00,000.00 1 20,00,000.00 2 20,00,000.00 3 20,00,000.00 4 20,00,000.00 5 20,00,000.00 6 20,00,000.00 7 20,00,000.00 8 20,00,000.00 9 20,00,000.00 10 20,00,000.00 11 20,00,000.00 12 20,00,000.00 Rate 20% NPV -9,34,638.79

As the NPV of the savings because of the new equipment and investment in the new equipment at 20% rate of return is negative the company should not buy the equipment.

1. Assuming the depreciation in the old equipment?

The book value of the old equipment wont change anything, because depreciation is not a cash outflow but a tax deductible expenditure. In the above case tax is 0 therefore, depreciation won’t have any impact on decision and thus the decision remains the same i.e. not to invest in new equipment.

1. If the old equipment has a salvage value?
 Question 3 Year Cash Flows 0 -70,00,000.00 1 20,00,000.00 2 20,00,000.00 3 20,00,000.00 4 20,00,000.00 5 20,00,000.00 6 20,00,000.00 7 20,00,000.00 8 20,00,000.00 9 20,00,000.00 10 20,00,000.00 11 20,00,000.00 12 20,00,000.00 Rate 20% NPV 15,65,361.21

If the old equipment has a salvage value now it would reduce the initial cash outflow and thus the company should invest in the decision as it results in positive NPV.

## Part B

1. What should company do?
 Part B Question 1 Year Cash Flows 0 -2,00,00,000.00 1 50,00,000.00 2 50,00,000.00 3 50,00,000.00 4 50,00,000.00 5 50,00,000.00 6 50,00,000.00 7 50,00,000.00 8 50,00,000.00 9 50,00,000.00 10 50,00,000.00 Rate 20% NPV 801967.02

The company should install the new equipment as it would result in positive NPV at 20% cost of capital

1. Where company went wrong?

It is hard to say where the company went wrong because two year back if the company installed the new equipment they had no idea that a new equipment will come in the market in next two years. As per our previous calculations the company should not have gone for the decision but that was irrespective of whether a new equipment will come in the market. Therefore, before investing in any new equipment a company should properly research the current trends regarding the new product.

## Part C

1. Should the company buy equipment?
 Question 1 Year Cash Flows 0 -1,00,00,000.00 Calculation of Annual Cash Flow 1 15,33,333.00 Savings 2000000 2 15,33,333.00 Less: Dep 833333 3 15,33,333.00 PBT 1166667 4 15,33,333.00 Tax @ 40% 466667 5 15,33,333.00 PAT 700000 6 15,33,333.00 Add: Dep 833333 7 15,33,333.00 Cash Flow 1533333 8 15,33,333.00 9 15,33,333.00 10 15,33,333.00 11 15,33,333.00 12 15,33,333.00 Rate 12% NPV -448179.9873

As tax has come into consideration, the savings will increase the tax of the company, whereas depreciation which is a non-cash expenditure will decrease the tax component of the company.But given the negative NPV the company still should not consider the new equipment as it still results in negative NPV.

1. If the old machine has book value?
 Question 2 Year Cash Flows Calculation of Initial Cash Outflow 0 -80,80,000.00 Purchase of Machine -10000000 1 15,33,333.00 Sale of Old Mach 0 2 15,33,333.00 Loss on Sale of Old Mach 4800000 3 15,33,333.00 Tax Saved on Loss 1920000 4 15,33,333.00 Net Outflow of Cash -8080000 5 15,33,333.00 6 15,33,333.00 7 15,33,333.00 8 15,33,333.00 9 15,33,333.00 10 15,33,333.00 11 15,33,333.00 12 15,33,333.00 Rate 12% NPV 1266105.727

If the old machinery has book value and zero salvage value than it would result in loss on sale of machinery which will reduce the overall profit of the company and thus reduce the tax burden on the company. Therefore, the tax of the old machinery’s loss is considered as a cash inflow.

The company should accept the project ass it results in positive NPV.

# United Technologies

 Year Purchasing Assembly 0 78500 0 1 -834400 -868500 2 -834400 -868500 3 -834400 -868500 4 -834400 -868500 5 -834400 -900000 6 -840000 -900000 7 -840000 -900000 NPV @ 20% -57,73,500.00 -61,74,000.00

 Purchasing Initial Cash Flow Sale of old Machinery 50000 Loss on Sale of Mach 310000 Tax Saved on Sale 108500 Purchase of New Equipment 80000 Total Cash Inflow/(Outflow) 78500 Annual Purchase of Components 830000 Difference of Salary 10000 Tax Save on Dep 5600 Cash Outflow 834400

The company should go for Purchasing the new equipment, as it has higher NPV as compared to continuing the same equipment. The sale of old machinery will ultimately result in positive cash flow as the loss on sale of old machinery is tax deductible. The difference of the operator’s salary has been considered as the annual cash outflow. If the old machinery is continued the depreciation will be applied for 4 years and thus it is also a tax-deductible expense

1. Other issues that could have taken into account are:
1. The capacity of the warehouse, even though the warehouse is empty right now the but after 4 years the capacity wont be available thus company needs to plan that right now
2. The quality of the material should be on par with the quality that we were producing
3. Due to bigger lot size the company will have more cash stuck in the inventory which could have been invested somewhere else
4. The credit period the supplier is willing to give

# MCI

 Cost of Equity 14.35% Growth Rate 5% Q1 FCFE -\$295 -\$442 -\$872 -\$1,042 -\$1,451 \$163 \$716 \$916 NPV -1864.457 Q2 FCFE -\$295 -\$442 -\$872 -\$1,042 -\$1,451 \$163 \$716 \$916 Terminal Value 9796.791 Total Cash Flow -\$295 -\$442 -\$872 -\$1,042 -\$1,451 \$163 \$716 \$10,713 NPV 1486.70 Share Outstanding 117.20 Price per Share 12.69

If there is no terminal value the current value of the company is \$ -1864.457 million.

If we consider the terminal value of the company the price per share is \$ 12.69 which means the share of the company is overvalued.

5 – (a) We know that the CDF function of a Weibull distribution is as follows: F(t)=1-e^(?-(t/c)?^m ) Rearranging it for the time of failure t = c*(-Ln(1 – F(t))) On randomising the CDF, we get the random times of failure. The randomisation has been done using the rand function of Excel which gives equal probability to the CDF of Weibull distribution. Time of Failure =c*((-Ln (1-Rand()))^(1/m)) c is characteristic life and m is shape parameter, the two parameters of a Weibull distribution. In our

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