Chapter 12: The Capital Budgeting Decision
First determine the book value of the asset.
Percentage
Depreciation Depreciation Annual
Year Base (Table 12-9) Depreciation
32. Capital budgeting with cost of capital computation (LO12-5) DataPoint Engineering is
considering the purchase of a new piece of equipment for $240,000. It has an eight-year
midpoint of its asset depreciation range (ADR). It will require an additional initial
investment of $140,000 in nondepreciable working capital. Thirty-five thousand dollars of
this investment will be recovered after the sixth year and will provide additional cash flow
Chapter 12: The Capital Budgeting Decision
for that year. Here is the projected income before depreciation and taxes for the next six
years:
Year Amount
1…………………. $185,000
2…………………. 160,000
3…………………. 130,000
4…………………. 115,000
5…………………. 95,000
6 ………………… 85,000
The tax rate is 25 percent. The cost of capital must be computed based on
the following (round the final value to the nearest whole number):
Cost (aftertax)
Weights
Debt ……………………………………………………
Kd
9.5%
25%
Preferred stock …………………………………….
Kp
13.2
25
Common equity (retained earnings). ……….
Ke
18.0
50
a. Determine the annual depreciation schedule.
b. Determine annual cash flow. Include recovered working capital in the sixth year.
c. Determine the weighted average cost of capital.
d. Determine the net present value. Should DataPoint purchase the new equipment?
12–32. Solution:
DataPoint Engineering
a. An eight-year midpoint of the ADR leads to five-year
MACRS depreciation.
Percentage
Chapter 12: The Capital Budgeting Decision
f. Depreciation schedule on the new equipment
Percentage
Depreciation Depreciation Annual
Year Base (Table 12-9) Depreciation
1 $148,000 .200 $ 29,600
6 148,000 .058 8,584
Chapter 12: The Capital Budgeting Decision
4
3,414
37,500
40,914
.636
26,021
5
4,255
35,250
39,505
.567
22,399
6
2,146
27,000
29,146
.507
14,777
Present Value of Incremental Benefits
$180,869
k. Present Value of Incremental Benefits $180,869
Calculator Solution:
Using a financial calculator,
Press the following keys: 2nd, CF, 2nd, Clear.
Calculator displays CF0, press 122,440 +|–, press the Enter key.
Press down arrow, enter 51,116, and press Enter.
Press down arrow, enter 1, and press Enter.
Press down arrow, enter 50,673, and press Enter.
Press down arrow, enter 1, and press Enter.
Press down arrow, enter 44,437, and press Enter.
Press down arrow, enter 1, and press Enter.
Press down arrow, enter 40,914, and press Enter.
Press down arrow, enter 1, and press Enter.
Press down arrow, enter 39,505, and press Enter.
Press down arrow, enter 1, and press Enter.
Press down arrow, enter 29,146, and press Enter.
Press down arrow, enter 1, and press Enter.
Press NPV; calculator shows I = 0; enter 12 and press Enter.
Press down arrow; calculator shows NPV = 0.00.
Press CPT, calculator shows NPV = 58,416.23, which is the NPV of the project.
Based on the present value analysis, the equipment should be replaced.
Chapter 12: The Capital Budgeting Decision
COMPREHENSIVE PROBLEM
The Woodruff Corporation purchased a piece of equipment three years ago for $230,000. It has
an asset depreciation range (ADR) midpoint of eight years. The old equipment can be sold for
$90,000.
A new piece of equipment can be purchased for $320,000. It also has an ADR of eight years.
Assume the old and new equipment would provide the following operating gains (or losses)
over the next six years:
New Equipment
Old Equipment
1 …………..
$80,000
$25,000
2 …………..
76,000
16,000
3 …………..
70,000
9,000
4 …………..
60,000
8,000
5 …………..
50,000
6,000
6 …………..
45,000
(7,000)
The firm has a 25 percent tax rate and a 9 percent cost of capital. Should the new equipment
be purchased to replace the old equipment?
