Reference no: EM133099836

Question - RD Resources Ltd. is planning on reworking one of its old oil wells. This well was drilled and completed in 2014 and is in need of new oil well equipment. The old oil well 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 selling price of a barrel of oil is $60.

The new equipment is expected to last for eight years and cost $12 million; one third immediate down payment and the balance due in two equal instalments due at the end of each of the next two years. The following cash flows have been budgeted:

The annual additional maintenance costs on the new equipment will be $1.2 million.

Annual reduction in supervision salaries: $600,000

Annual savings in increased efficiencies: $500,000

The investment in working capital for the new equipment is $600,000.

At the end of its eight year life the new equipment is budgeted to have a salvage value of $2 million.

The new equipment will increase production by 40,000 barrels per year (one time increase of 40,000/year for the next 8 years).

After four years a major overhaul (costing $1.5 million) of the new equipment will be required. This will be treated for tax and accounting purposes as a capital addition.

The overhaul 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 tax shield formula. You do not need 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.