#2 (10 points)
Case study Bonzai Company
Bonzai Company (BC) is a medium-sized commercial printer of promotional advertising brochures, booklets, and other direct-mail pieces. The firm's major clients are ad agencies based in New York and Chicago. The typical job is characterized by high quality and production runs of more than 50,000 units. BC has not been able to compete effectively with larger printers because of its existing older, inefficient presses. The firm is currently having problems cost-effectively meeting run length requirements as well as meeting quality standards.
The general manager has proposed the purchase of one of two large, six-color presses designed for long, high-quality runs. The purchase of a new press would enable BC to reduce its cost of labor and therefore the price to the client, putting the firm in a more competitive position. The key financial characteristics of the old press and of the two proposed presses are summarized in what follows.
Old press Originally purchased 3 years ago at an installed cost of $400,000, it is being depreciated under MACRS using a 5-year recovery period. The old press has a remaining economic life of 5 years. It can be sold today to net $420,000 before taxes; if it is retained, it can be sold to net $150,000 before taxes at the end of 5 years.
Press A This highly automated press can be purchased for $830,000 and will require $40,000 in installation costs. It will be depreciated under MACRS using a 5-year recovery period. At the end of the 5 years, the machine could be sold to net $400,000 before taxes. If this machine is acquired, it is anticipated that the following current account changes would result:
Press B This press is not as sophisticated as press A. It costs $640,000 and requires $20,000 in installation costs. It will be depreciated under MACRS using a 5-year recovery period. At the end of 5 years, it can be sold to net $330,000 before taxes. Acquisition of this press will have no effect on the firm's net working capital investment.
Earnings Before Depreciation, Interest, and Taxes for Bonzai Company's Presses
120,000 120,000 120,000 120,000 120,000
$250,000 270,000 300,000 330,000 370,000
$210,000 210,000 210,000 210,000 210,000
The firm estimates that its earnings before depreciation, interest, and taxes with the old press and with press A or press B for each of the 5 years would be as shown in Table 1 The firm is subject to a 40% tax rate. The firm's cost of capital, k, applicable to the proposed replacement is 14%.
a. For each of the two proposed replacement presses, determine:
Operating cash inflows....