Golden Corporation is considering the purchase of new equipment costing $200,000

Question

Golden Corporation is considering the purchase of new equipment costing $200,000. The expected life of the equipment is 10 years. It is expected that the new equipment can generate an increase in net income of $35,000 per year for the next 10 years. The probabilities for the increase in net income depend on the state of the economy.
After tax

After tax probabilities Net Income

Recession .3 ($15,000)

Normal .5 25,000

Boom .2 35,000

The equipment can be amortized using straight-line amortization for tax purposes. Golden's cost of capital is 14%. What is the expected NPV? Should they purchase the new equipment?

Amortization Schedule:

200,000 = $20,000

10,000

Explanation / Answer

Depreciation = 200,000/10= 20,000

Recession

Cash flow = -$15,000+ 20000= 5000

NPV = -200000 + 5000*(1-1/1.14^10)/14%=    (173,919.42)

Cash flow in Normal = 25,000+20000= 45000

NPV = -200000 + 45000*(1-1/1.14^10)/14%=34725.20

Cash flow in Boom = 35,000+20000= 55000

NPV = = -200000 + 55000*(1-1/1.14^10)/14%=86886.361

Expected NPV = 0.3*(173,919.42)+ 0.5*34725.20 + 0.2*86886.361=      -17,435.95

they should not purchase the new equipment

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