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 0.3                ($15,000)

Normal    0 .5                  25,000

Boom                                                                  0.2                   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

Please show all work

Explanation / Answer

Annual depreciation = 200000/10= 20000

Recession, cash flow = -15000+ 20000= 5000

NPV = -200000 +5000*(1-1/1.14^10)/14%=-173919.42

Normal, cash flow = 25000+ 20000= 45000

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

Boom, cash flow = 35000+ 20000= 55000

NPV = -200000 +55000*(1-1/1.14^10)/14%=$86886.36

Expected NPV = 0.3*(-173919.42)+ 0.5*34725.20+ 0.2*86886.36=-17435.95

They should not purchase the new equipment because expected NPV is negative

Related Questions

Navigate

• Browse (All)
• Browse G
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.