Capital Budgeting: Mann Company has estimated its cost of capital at 12%. The fi
ID: 2497795 • Letter: C
Question
Capital Budgeting:
Mann Company has estimated its cost of capital at 12%. The firm is considering buying a new printing press that will cost $700,000. This new printing press will have a four-year life and will have a $200,000 salvage value at the end of its useful life. The new machine will generate an estimated $200,000 per year in net operating cash flows (before taxes). The firm’s tax rate is 25%. Assume the firm will take $125,000 in depreciation expense for tax purposes in each of the four years.
Required: Based on the information provided, determine the net present value of this machine.
$_________________ Net Present Value
Explanation / Answer
Answer: The Net Present Value is - $ 22,343.75
Calculation of annual cash flows:
Net operating cash flow before tax $ 200,000
Less depreciation 125,000
EBT 75,000
Tax @ 25% 18,750
Earnings after tax 56,250
Add depreciation 125,000
Net annual cash flows 181,250
If the cost of capital is 12%, the present value of one dollar for 4 years 3.037
Therefore present value of net annual cash inflows is 181,250 x 3.037 = $ 550,456.25
Present value of salvage price 200,000 x 0.636 = $ 127,200
Hence Present value of cash inflows $ 677,656.25
Present value of cash outflows $ 700,000
Net present value - $ 22,343.75
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