For this question start fresh, do not carry over data from earlier questions. Yo

Question

For this question start fresh, do not carry over data from earlier questions. You are analyzing the prospects of installing cost saving machinery. You have the following information: The machine costs $80,000. Depreciation is calculated straight line (equal amounts) over 4 years. Every year the machine increases cash flows by an amount 40,000. (Taxes, Opportunity Cost etc. have all been accounted for in this number. There is no Net Working Capital.) After 3 years (when the machine has only been depreciated for 3 years and therefore the book value is not zero) the machine is sold for $30,000. This, therefore, is a 3 year project. The rate of discount is 8% The tax rate is 36%. (Hint: Here you have to consider the income due to the salvage sale of the machinery and the taxes on this sale.) What is the NPV of installing the machinery?

Explanation / Answer

Annual depreciation = 80,000 / 4 = 20,000

Year 3 non-operating cash flow = Salvage value - tax ( salvage value - book value)

Year 3 non-operating cash flow = 30,000 - 0.36(30,000 - 20,000)

Year 3 non-operating cash flow = 30,000 - 3,600

Year 3 non-operating cash flow = 26,400

NPV = Present value of cash inflows - present value of cash outflows

NPV = -80,000 + 40,000 / ( 1 + 0.08)1 + 40,000 / ( 1 + 0.08)2 + 66,400 / ( 1 + 0.08)3

NPV =44,041.05

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