Regarding the net present value of a replacement decision, which of the following statements is false?
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A. B. C. D. E.Explanation
Since the old equipment is sold at a loss which reduces taxable income, a tax savings is realized and is deducted from the investment outlay.
The false statement regarding the net present value (NPV) of a replacement decision is B. The present value of depreciation expenses on the new equipment, multiplied by the tax rate, is treated as an inflow.
To understand why statement B is false, let's first review the concept of net present value (NPV). NPV is a technique used to evaluate the profitability of an investment or project. It calculates the present value of all future cash flows associated with the investment, taking into account the time value of money.
In the context of a replacement decision, the NPV compares the cash flows associated with replacing old equipment with new equipment over a specific time period. The cash flows can be categorized as inflows (positive cash flows) or outflows (negative cash flows) depending on their timing and nature.
Now, let's analyze each statement to determine which one is false:
A. The present value of the after-tax cost reduction benefits resulting from the new investment is treated as an inflow. This statement is true. When making a replacement decision, one of the benefits of the new equipment is the cost reduction it provides. The after-tax cost reduction benefits are treated as inflows because they increase the cash flows available to the project.
B. The present value of depreciation expenses on the new equipment, multiplied by the tax rate, is treated as an inflow. This statement is false. Depreciation expenses on the new equipment are not treated as inflows. Depreciation is a non-cash expense that reflects the reduction in the value of an asset over time. It is not an actual cash flow, and therefore, it does not affect the net cash flows available to the project. The treatment of depreciation expenses is typically accounted for separately when calculating taxable income.
C. An increase in net working capital is treated as an outflow when the project begins and as an inflow when the project ends. This statement is true. When a project begins, there is usually a need for additional working capital to support the operations. This increase in net working capital is considered an outflow because it represents an investment of cash. However, when the project ends, the net working capital is typically recovered, resulting in a positive cash flow, which is considered an inflow.
D. Any loss on the sale of the old equipment is multiplied by the tax rate and is treated as an outflow at t = 0. This statement is true. When old equipment is replaced, if there is a loss on the sale of the old equipment, it is multiplied by the tax rate and treated as an outflow at the beginning of the project (t = 0). This is because the loss reduces the cash flow available to the project and is subject to taxes.
E. The after-tax market value of the old equipment is treated as an inflow at t = 0. This statement is true. The after-tax market value of the old equipment is treated as an inflow at the beginning of the project (t = 0). When the old equipment is sold, the after-tax proceeds from the sale increase the cash flows available to the project and are treated as an inflow.
In summary, the false statement is B. The present value of depreciation expenses on the new equipment, multiplied by the tax rate, is not treated as an inflow. Depreciation expenses are non-cash expenses and do not impact the net cash flows available to the project.