LASTING IMPRESSIONS COMPANY

A. For each of the two proposed replacement presses, determine:

(1) Initial investment.

Installed cost of new press

Cost of new press
Installation cost
Total Cost - New Press
After-tax proceeds-sale of old asset
Proceeds from sale of old press
Tax on sale of old press
Total proceeds-sale of old press
Change in net working capital
Initial investment

$(420,000.00)
(121,600.00)
$(298,400.00)

PRESS A

PRESS B

$830,000.00
40,000.00
$870,000.00

$640,000.00
20,000.00
$660,000.00

$(298,400.00)
$90,400.00
$662,000.00

$(298,400.00)
$361,600.00

Tax on sale of old press

Sale Price
Book Value $ 400,000 - [(.20 +.32 +.19) x $400,000]
Gain
Tax Rate (40%)
Tax on sale of old press

$420,000.00
(116,000.00)
$304,000.00
40%
$121,600.00

Computation for Change in net working capital

Cash
Accounts Receivable
Inventory
Increase in current assets
Increase in current liabilities
Increase net working capital

$25,400.00
120,000.00
(20,000.00)
$125,400.00
(35,000.00)
$90,400.00

(2) Operating cash inflows (considered depreciation in year 6)

Existing
1
2
3
4
5
6

$400,000.00
$400,000.00
$400,000.00

Cost Rate
0.12
0.12
0.05

Depreciation
$48,000.00
$48,000.00
$20,000.00

$116,000.00

Press A
1
2
3
4
5
6

Press B
1
2
3
4
5
6

$870,000.00
$870,000.00
$870,000.00
$870,000.00
$870,000.00
$870,000.00

Cost Rate
0.20
0.32
0.19
0.12
0.12
0.05

Depreciation
$174,000.00
$278,400.00
$165,300.00
$104,400.00
$104,400.00
$43,500.00
$870,000.00

$660,000.00
$660,000.00
$660,000.00
$660,000.00
$660,000.00
$660,000.00

Cost Rate
0.20
0.32
0.19
0.12
0.12
0.05

Depreciation
$132,000.00
$211,200.00
$125,400.00
$79,200.00
$79,200.00
$33,000.00
$660,000.00

(3) Terminal Cash Flow (At the end of year 5)

PRESS A

PRESS B

$400,000.00
(142,600.00)
$257,400.00

$330,000.00
(118,800.00)
$211,200.00

(90,000.00)

(90,000.00)

After tax proceed from sale of new

press
Proceeds of sale of new press
Tax on sale of new press
Total Proceeds-new press
After-tax proceeds-sale of old press :
Proceeds on sale of old press
Tax on sale of old press
Total proceeds-sale of old press

$(150,000.00)
(60,000.00)
(90,000.00)

Change in net working capital

Terminal Cash flow

$90,400.00
$257,800.00

Computation for Tax on sale of new press

PRESS A
$400,000.00
$(43,500.00)
$356,500.00
40%
$142,600.00

Sale price
Book Value (Yr 6)
Gain
Tax Rate (40%)
Tax on sale of new press

PRESS B
$330,000.00
$(33,000.00)
$297,000.00
40%
$118,800.00

Computation for Tax on sale of old press

Sale price
Book Value (Yr 6)
Gain
Tax Rate (40%)
Tax on sale of old press**
Initial Investment
Year 1
Year 2
Year 3
Year 4
Year 5*

$150,000.00
0.00
$150,000.00
40%
$60,000.00
PRESS A
$662,000.00
Cash Inflow
$128,400.00
$182,160.00
$166,120.00
$167,760.00
$449,560.00

PRESS B
$361,600.00
Cash Inflow
$87,600.00
$119,280.00
$96,160.00
$85,680.00
$206,880.00

$191,760.00
$257,800.00
$449,560.00

$85,680.00
$121,200.00
$206,880.00

* Operating cash flow

+ Terminal cash inflow
Cash inflows year 5*

B. Using the data developed in Part A, find and depict on a time line the relevant cash
flow stream associated with each of the two proposed presses, assuming that each is
terminated at the end of 5 years.

Operating Cash Inflows

$0.00
$121,200.00

$182,160.00
$128,400.00

1
6

$167,760.00
$166,120.00

$449,560.00

End of Year

Operating Cash Inflows

$119,280.00
$87,600.00

1
6

$85,680.00
$96,160.00

$206,880.00

End of Year

C. Using the data developed in Part B, apply each of the following decision techniques:

Year 1
Year 2
Year 3
Year 4
Year 5

CUMMULATIVE CASH FLOWS

PRESS A
PRESS B
$128,400.00
$87,600.00
$310,560.00
$206,880.00
$476,680.00
$303,040.00
$644,440.00
$388,720.00
$1,094,000.00
$595,600.00
Payback period

Press A
4 years + [(662,000 - 644,440)/191,760]
= 4 + (17,600/191,760)
= 4 + 0.9178
= 4.09 years

Press B
3 years + [(361,600 - 303,040)/85,680]
= 3 + (58,560/85,680)
= 3 + .68347
= 3.8 years

E. Recommend which, if either, of the presses the firm should acquire if the firm has (1)
unlimited funds or (2) capital rationing.
The firm should acquire Press A if they have unlimited funds, but if the firm is
subject to capital rationing, then the firm should choose to acquire Press B over Press
A.
F. What is the impact on your recommendation of the fact that the operating cash
inflows associated with Press A are characterized as a very contrast to the low-risk
operating cash inflows of press B?

Taking the risk levels into account, I would have to elect to recommend the lower
risk option that Press B presents .I would prefer to take lower risk (but more
guaranteed) operating cash inflows that it would provide. The risk would need to be
measured by a quantitative technique such as certainty equivalents or risk-adjusted
discount rates. The resultant present value could then be compared to Press B and a
decision made.