World Domination Enterprises is considering the purchase of equipment with a cos

Question

World Domination Enterprises is considering the purchase of equipment with a cost of $800,000, a salvage value

of $100,000, and an estimated useful life of 5 years. World Domination depreciates all equipment using the

straight-line method. Additionally, it expects to be subject to a tax rate of 25% in all 5 years.

World Domination projects the following gross cash flows directly resulting from equipment operations:

Year 1                          $ 260,000

Year 2                          $ 370,000

Year 3                          $ 310,000

Year 4                          $ 270,000

Year 5                          $ 190,000

World Domination uses a time value of money rate of 9% for decision-making purposes.

A) Calculate the payback period of the investment in the equipment.

B) Calculate the net present value of the investment in the equipment.

C) Calculate the profitability index of the investment in the equipment.

Explanation / Answer

Wsorld Domination Enterprises Details Amt $ Cost of Machine                  800,000 Less Salvage                  100,000 Depreciable value                  700,000 Useful life                               5 SL depreciation per year                  140,000 NPV calculation Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Investment in Machine                (800,000) Salvage         100,000 Gross Cash Flow from Opeartions        260,000        370,000        310,000       270,000       190,000 Less : Depreciation      (140,000)      (140,000)      (140,000)     (140,000)     (140,000) Taxable Income        120,000        230,000        170,000       130,000          50,000 Tax @25%        (30,000)        (57,500)        (42,500)       (32,500)       (12,500) Post Tax Income           90,000        172,500        127,500         97,500          37,500 Add Back depreciation        140,000        140,000        140,000       140,000       140,000 Net Cash Flow(with salvage)                (800,000)        230,000        312,500        267,500       237,500       277,500 PV factor @9%                               1             0.917             0.842             0.772            0.708            0.650 PV of Cash flows                (800,000)        211,009        263,025        206,559       168,251       180,356 b NPV = $        229,200.20 PV of Cash Inflows              1,029,200 PV of investment=                  800,000 c Profitability Index=PV of Cash Inflows/PV of Investment                         1.29 a Payback Period in years=                         3.04

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