If a company hired you to estimate the cash flows arising from a proposed capita
ID: 2637327 • Letter: I
Question
If a company hired you to estimate the cash flows arising from a proposed capital project by replacing old equipment with a $0 market value and a book value of $7000, and you have been handed the relevant data below. The project being considered has a 5-year tax life, and at the end of year 5 the asset will be worthless (i.e. salvage value =0). The CFO suggests that you depreciate the asset by using the straight-line method over the 5 year life of the project. Revenues and other operating costs are as noted below, and will be constant over the period. Equipment cost: $158,000; Book value of old equipment: $7000 Delivery and installation cost of equipment and remove old equipment: $45,000; Straight-line depreciation rate: 20% (5-year); Sales revenue each year: $115,000 Operating costs (excluding depreciation): $38,000; Tax rate: 35% What is the net present value of this project and should you convince the CFO to accept or reject the new equipment?
Explanation / Answer
the cost of the equipment= $158,000
straight line depreciation= 20%, 5 years life
depreciation per each year= $31,600
revenue generates in each year= $115,000
other expense= $38,000
total cost per year= $31,600 + $38,000= $69,600
net revenue per year= $115,000 - $69,600= $45,400
the revenue for 5 years= $45,400 X 5= $227,000
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