Reference no: EM133115971

Question - TC Technology Ltd. is planning on reworking one of its old chip plants. This plant was completed in 2017 and requires an upgrade of new chip production equipment. The old equipment has a net book value of $2 million, a remaining useful life of 2 years (at which time it will have no salvage value), and a current salvage value of $500,000. The previous project had required working capital of $150,000.

The selling price per chip is $25.

The new equipment is expected to last for six years and cost $11 million; one half due at the start of the project and the balance due in one year. The following cash flows have been budgeted:

The annual additional programming and maintenance costs on the new equipment will be $1.1 million.

Annual reduction in rework and scrap costs: $400,000.

Annual savings in increased efficiencies: $500,000.

The investment in working capital for the new equipment is $300,000.

At the end of its six-year life the new equipment is budgeted to have a salvage value of $1 million.

The new equipment will increase production by 120,000 chips per year (one time increase of 120,000 per year for the next six years).

After three years a major upgrade (costing $2.5 million) of the new equipment will be required. This will be treated for tax and accounting purposes as a capital addition. The upgrade has no effect on the salvage value.

REQUIRED -

1. Compute the annual after tax cash flow from the new equipment. Include any tax benefits related to the new equipment in the initial investment calculation. Use the tax shield formula for Part 2 - you do not have to calculate CCA for each year.

2. Using your answer from #1 above, compute the net present value of the investment in the new equipment.