solution

Read this case study and then answer the questions that
follow.

Janice Joplin owns the Radical Music Company and needs a new
recording machine as technology is quickly changing. The best
machines are available in Canada. Janice decides to visit Canada to
determine which machine to purchase. The cost of this trip was
$22,000. Based on the trip she will purchase the Mendez 100. Once
the decision is made to purchase, she will need to travel to Canada
to undertake training. This will cost $18,000. Both trips are tax
deductible in year 0. The Mendez 100 will cost $2,650,000 and
should be able to be sold for $120,000. The accountant has advised
that the machine will be depreciated over 10 years. The ATO however
requires depreciation over 12 years. It is expected that the
machine will be kept for 5 years by Radical Music so any evaluation
must be undertaken over a 5-year period. The accountant is adamant
that depreciation will need to be over 10 years for analysing this
project. Janice will need to borrow 90% of the value of the Mendez
100 from the Eastern Bank. The loan will be at a fixed rate of 19%
p.a. over 15 years, with interest only payable at the end of each
year. The principal is repayable at the end of the fifth year. The
old machine was purchased three years ago and at that time was
expected to have an economic life of 5 years. It cost $280,000 and
Janice has been depreciating it using straight-line depreciation
over 5 years as required by the ATO. Janice expects she will
receive $60,000 if she sells the old machine. It is expected to be
sold in period 0 if the new machine is purchased. The Mendez
machine is state-of-the-art, and much more efficient than the old
machine. The old machine costs $1,350,000 per annum to operate,
whereas the new machine will only cost about $275,000 per annum to
operate. Due to the different way the Mendez operates, it will be
necessary to purchase an additional $24,000 of inventory in year 0.
Janice will need less staff because of the new machine. This will
require a payout of $220,000 in year 0 and save wages of $92,000
per year. These amounts are tax deductible. All cash flows are
given in nominal terms. The nominal rate of interest currently in
the economy is 8% and inflation is 4%. The real rate of interest is
3.85% and the WACC is 16% The corporate tax rate is 7%. Assume tax
is paid in the year of income. The new machine will generate yearly
revenue of $14m while the old machine was only able to generate
annual revenue of $1.9m. Assume that all incremental revenues (as
identified in line 12 above) and expenses (as identified in line 6
above) continue to year 5. That is, include these incremental
amounts in your calculation in question 8.

1) What amount (before taxes) of the trip to Canada should be
included when undertaking the NPV analysis? (1 Mark) Answer to the
nearest dollar. Do not use $ or , signs in answer Answer: $Answer 0
2) The after-tax impact from Eastern Bank to be included in the NPV
calculation is: (1 Mark) Answer to the nearest dollar. Do not use $
or , signs in answer Answer: $Answer 3) The depreciation tax shield
(tax benefit per annum) for the new machine is: (1 Mark) Answer to
the nearest cent. Do not use $ or , signs in answer Answer: $Answer
1545.83 (answer to two decimal places) 4) The lost depreciation tax
shield (tax benefit per annum) for the old machine is in year 5 is:
(1 Mark) Answer: $Answer 3920 5) Janice must purchase additional
inventory. The cash flow impact of this in year 0 will be? (1Mark)
Answer to the nearest dollar. Do not use $ or , signs in answer
Answer : $Answer Answer 6) The Cash Flow in period 0 is: (2 Marks)
Answer to the nearest dollar. Do not use $ or , signs in answer
Answer :$Answer (a negative sign may be used in the answer) 7) The
appropriate discount rate to use in deciding whether Janice should
buy the new machine is. (1 Mark) Answer : Answer (Answer as a
Decimal to 4 decimal places E.g. if the answer is 2.56% answer as
.0256 only.) 8) The Free Cash Flow in year 5 is: (2 Marks) Answer
to the nearest cent. Do not use $ or , signs in answer Answer:
$Answer (answer to two decimal places)