Accounting Question

Logic Construction Cc has an excavator currently in use which was originally bought two years ago for N$ 320, 000. The excavator is being depreciated under MACRS using a five-year recovery period, and it has three years of usable life remaining. This excavator can be sold today to net N$ 336, 000 after all costs associated with its disposal have been considered. A new modern excavator, using a three year MACRS recovery period; can be purchased at a price of N$ 1, 120, 000. The new modern excavator has a useful life of three years and its purchase price excludes installation costs which amount to N$ 80, 000. If the new modern excavator is procured, the company’s current assets will increase by N$ 280, 000 while its current liabilities will increase by N$ 120, 000. EBDIT is expected to be N$ 560, 000 for each of the three years with the old excavator and N$ 960, 000 in the first year, and N$ 1,040, 000 in the second and third years with the new modern excavator. At the end of three years, the market value of the old excavator will be zero, but the new modern excavator could be sold for 25% of its purchase price excluding installation costs before taxes. Consider a corporate tax rate of 40% and a 12% cost of capital.

2.2.

Use the information above to answer the following questions:

2.2.1.

Compute the initial investment associated with the proposed replacement decision.

5

2.2.2.

Compute the applicable operating cash inflows for years one to four, for each excavator associated with the proposed replacement decision.

10

2.2.3.

With the help of your answers in (2.2.2), compute the incremental operating cash inflows for years one to four associated with the proposed replacement decision.

4

2.2.4.

How much is the terminal cash flow associated the proposed replacement decision? (Hint: This is at the end of year three).

5

2.2.5.

With the help of your answers in (2.2.1., 2.2.2. & 2.2.3.), on the basis of NPV, should the new modern excavator be purchased?

11

TOTAL MARKS

35