The plant has accumulated savings of $80,000 to acquire a new machine for the Ma

Question

The plant has accumulated savings of $80,000 to acquire a new machine for the Manufacture Department The new machine costs $80,000. The Straight line depreciation method is used buy this plant in all its equipments. The income tax rate is 0.35. The new equipment will save $35,000 each year and is economic life is 5 years. The salvage value is S 10,000. Does the acquisition of this new machine satisfy the 8% minimum rate? compute the present worth after tax cash flow O a $37,204 b.-$80,000 OC $66,550 O d,-$18,693

Explanation / Answer

ANSWER: ALL THE CALCULATIONS HAVE BEEN DONE IN EXCEL.

INITIAL INVESTMENT = $80,000

SAVING PER YEAR = $35,000

SALVAGE VALUE = $10,000

R = 8%

N = 5 YEARS

CALCULATION OF DEPRECIATION IS DONE BY STRAIGHT LINE METHOD:

IN STRAIGHT LINE METHOD THE DEPRECIATION IS DONE BY DIVIDING THE VALUE OF MACHINE TO THE NO OF YEARS: 80,000 / 5 = 16,000

BEFORE TAX CASH FLOW IS CALCULATED BY ADDING ANNUAL SAVINGS AND SALVAGE VALUE AND SUBTRACTING DEPRECIATION AND THE REASON FOR SUBTRACTING DEPRECIATION IS TO HAVE THE BENEFIT IN THE TAX RATE.

SINCE IS TAX IS 0.35 OR 35% , IT IS CALUCLATED BY MULTIPLYING 0.35 TO THE BEFORE TAX CASH FLOWS.

AFTER TAX CASH FLOW IS CALCULATED BY SUBTRACTING TAX FROM BEFORE TAX CASH FLOW AND FOR YEAR 0 IT WILL BE 80,000 ( THE INITIAL INVESTMENT).

WE ADD BACK DEPRECIATION IN FINDING THE PRESENT WORTH TO THE AFTER TAX CASH FLOW.

THE NET PRESENT VALUE IS FOUND OUT BY USING THE NPV FORMULA IN EXCEL.

=NPV(RATE,ALL THE CASH FLOWS FROM YEAR 1 TO 5 ) + YEAR 0 CASH FLOW

AND THE FINAL ANSWER IS $37,617 (APPROX) WHICH IS SIMILAR TO $37,204 AND THE CORRECT OPTION IS A AND THE ACQUISITION DOES SATISFY AT 8% MINIMUM RATE.

THE DIFFERENCE OF AROUND $400 IS DUE TO FACTORS AND ONE USED IN EXCEL.

YEAR 0 1 2 3 4 5 INITIAL INVESTMENT -80,000 ANNUAL SAVINGS 35,000 35,000 35,000 35,000 35,000 SALVAGE VALUE 10,000 DEPRECIATION -16000 -16000 -16000 -16000 -16000 BEFORE TAX CASH FLOW 19,000 19,000 19,000 19,000 29,000 TAX 6650 6650 6650 6650 10150 AFTER TAX CASH FLOW -80,000 12,350 12,350 12,350 12,350 18,850 AFTER TAX CASH FLOW + DEPRECIATION -80,000.0000000000 28,350 28,350 28,350 28,350 34,850 NET PRESENT VALUE 37,617.1203318831

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