Bottoms Up Diaper Service is considering the purchase of a new industrial washer

Question

Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $3,600 and sell its old washer for $900. The new washer will last for 6 years and save $1,100 a year in expenses. The opportunity cost of capital is 20%. and the firm's tax rate is 40%. a. If the firm uses straight-line depreciation to an assumed salvage value of zero over a 6-year life, what is the annual operating cash flow of the project in years 0 to 6? The new washer will in fact have zero salvage value after 6 years, and the old washer is fully depreciated. (Negative amount should be indicated by a minus sign.) Annual operating cash flow in year 0 Annu al operating cash flow in years 1 to 6 b. What is project NPV? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.) NPV c. What is NPV if the firm uses MACRS depreciation with a 5-year tax life? Use the MACRS depreciation schedule. (Do not round intermediate calculations. Round your answer to 2 decimal places.) NPV

Explanation / Answer

solution:

a. Annual operating cash flow in year 0 = -$3,600 + 900 = -$2,700

Annual operating cash flow in years 1 to 6 = $1,100(i.e.saving of exp.) + (3,600/6)*40%(i.e. tax saving on depreciation component)

= $1,100 + 240 = $1,340

b. computation of NPV of the project

NPV = present value of cash inflow - present value of cash outflow

= $1,340* sum of PV factor @20% - $2,700

= $1,340*3.32551 - 2,700 = $4,456.183 - 2,700

= $1,756.18 ( Rounded off to 2 decimal places)

note: Provide MACRS depreciation schedule for part c.

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