Lesson 9 Learning Objectives Chapter 12- Strategy and Capital Investments 12-29 Value of Accelerated Depreciation: Sum-of-Years’-Digits (SYD) and Double-Declining-Balance (DDB) Methods Freedom Corporation acquired a fixed asset for $100,000. Its estimate

Lesson 9 Learning Objectives Chapter 12- Strategy and Capital Investments 12-29 Value of Accelerated Depreciation: Sum-of-Years’-Digits (SYD) and Double-Declining-Balance (DDB) Methods Freedom Corporation acquired a fixed asset for $100,000. Its estimated life at time of purchase was four years, with no estimated salvage value. Assume a discount rate of 8% and an income tax rate of 40%. Required 1. What is the incremental present value (rounded to the nearest whole dollar) of the tax benefits resulting from calculating depreciation using the sum-of-the-years’-digits (SYD) method rather than the straight-line (SLN) method on this asset? Use the SYD and SLN functions in Excel to calculate depreciation charges. 2. What is the incremental present value (rounded to the nearest whole dollar) of the tax benefits resulting from calculating depreciation using the double-declining-balance (DDB) method rather than the straight-line (SLN) method on this asset? Use the SLN and DDB functions in Excel to calculate depreciation charges. 3. What is the incremental present value (rounded to the nearest whole dollar) of the tax benefits resulting from using MACRS rather than straight-line (SLN) depreciation? The asset qualifies as a three-year asset. Use the half-year convention. (Refer to Exhibit 12.4 for MACRS depreciation rates.) 12-33 Using Arrays in Excel; NPV Analysis Please refer to footnote 14 and the data referenced in the footnote. Required 1. Follow the directions given in footnote 14 to calculate the NPV of the referenced investment project. (Hint: If necessary, consult the following: 2. Repeat the procedure using a discount rate (WACC) of 10% and the following cash flows, time 0 through time 10: ($1,000), $100, $200, $300, $400, $500, $600, $700, $800, $900, $1,000. (Hints: The NPV should be $1,903.59; remember to use the Name Manager (Ctrl+F3) under the Formulas tab in Excel.) 12-38 Uneven Cash Flows; NPV; Sensitivity Analysis MaxiCare Corporation, a not-for-profit organization, specializes in health care for senior citizens. Management is considering whether to expand operations by opening a new chain of care centers in the inner city of large metropolitan areas. For a new facility, initial cash outlays for lease, renovations, net working capital, training, and other costs are expected to be about $15 million. The corporation expects the cash inflows of each new facility in its first year of operation to equal the initial investment outlay for the facility. Net cash inflows are expected to increase to $1 million in each of years 2 and 3; $2.5 million in year 4; and $3 million in each of years 5 through 10. The lease agreement for the facility will expire at the end of year 10, and MaxiCare expects the cost to close a facility will pretty much exhaust all cash proceeds from the disposal. Cost of capital for MaxiCare is estimated as 12%. Assume that all cash flows occur at year-end. Required 1. Compute (using the built-in NPV function in Excel) the net present value (NPV) for the proposed investment. Round your answer to nearest whole dollar. 2. Compute (using the built-in IRR function in Excel) the internal rate of return (IRR) for the proposed investment. Round your answer to 2 decimal places (e.g., 14.347% = 14.35%). 3. What is the breakeven selling price for this investment, that is, the price that would yield an NPV of $0? (Use the Goal Seek function in Excel to determine the breakeven selling price. See the instructions in the Uncertainty and the Capital Budgeting Process section of this chapter.) 12-46 Machine Replacement with Tax Considerations; Spreadsheet Application; Double-Declining-Balance (DDB) Depreciation A computer chip manufacturer spent $2,500,000 to develop a special-purpose molding machine. The machine has been used for one year and is expected to be obsolete after an additional three years. The company uses straight-line (SLN) depreciation for this machine. At the beginning of the second year, a machine salesperson offers a new, vastly more efficient machine. This machine will cost $2,000,000, reduce annual cash manufacturing costs from $1,800,000 to $1,000,000, and have zero disposal value at the end of three years. Management has decided to use the double-declining-balance (DDB) depreciation method for tax purposes for this machine if purchased. (Note: Make sure to switch to SLN depreciation in year 3 to ensure that the entire cost of the asset is written off. You may find it useful to use the VDB function in Excel to calculate depreciation charges.) The old machine’s salvage value is $300,000 now and is expected to be $50,000 three years from now; however, no salvage value is provided in calculating straight-line (SLN) depreciation on the old machine for tax purposes. The firm’s income tax rate is 45%. The firm desires to earn a minimum after-tax rate of return of 8%. Required 1. What is the present value (rounded to the nearest whole dollar) of tax savings associated with depreciating the existing machine (using the straight-line method)? 2. What is the present value (rounded to the nearest whole dollar) of tax savings associated with depreciating the new machine using the double-declining-balance method? Use the VDB built-in function in Excel to calculate depreciation deductions. 3. What is the present value of net after-tax cost associated with the existing machine? Round your answer to the nearest whole dollar. (Hint: There will be three items to consider.) 4. What is the present value (rounded to the nearest whole dollar) of the net after-tax cost of using the replacement (new) machine? 5. What is the estimated net present value (NPV) of the decision to replace the existing machine with the new machine. Round your final answer to the nearest whole dollar. (Note: Use the PV and NPV functions in Excel to calculate all present value amounts.)