Kerry Enterprises is considering the purchase of a new machine that will produce
ID: 2651413 • Letter: K
Question
Kerry Enterprises is considering the purchase of a new machine that will produce thumb drives. The new machine will require an initial investment of $800,000 and has an economic life of five years and will be fully depreciated by the straight line method. The machine will produce150,000 thumb drives per year with each costing $0.10 to make. Each will be sold at $2.00. Assume Kerry Enterprises uses a discount rate of 14 percent and has a tax rate of 34 percent. What is the NPV of the project and should Kerry Enterprises make the purchase? Make sure you show your work.
Explanation / Answer
Calculation of Yearly Cash Flow After Tax
Particular
Amount ($)
Selling Price per unit
2.00
Cost per unit
0.10
Profit Per unit
1.90
No of units
150,000
Earnings Before Depreciation and Tax (150,000 x 1.9)
285,000
Depreciation
160,000
Earning Before Tax ($800,000/5 )
125,000
Earning After Tax ( EBT x 0.66)
82,500
Add: Depreciation
160,000
Cash Flow After Tax
242,500
We know that interest factor for calculation of Present value when annual cash flow is given as under
(P/A, i %, n)= (1+’i)n -1 / ‘I x (1+i) n
Where i= 14%, and ‘n= 5 years
(P/A, 14 %, 5)= 3.433
NPV = Present Value fo Future Cash Inflows- Initial Investment
NPV=(242,500 x 3.433) – 800,000
NPV= 832,522-800,000
NPV= $ 32,522
Decision- As there is positive NPV hence Kerry Enterprises should go ahead for purchase of machine.
Particular
Amount ($)
Selling Price per unit
2.00
Cost per unit
0.10
Profit Per unit
1.90
No of units
150,000
Earnings Before Depreciation and Tax (150,000 x 1.9)
285,000
Depreciation
160,000
Earning Before Tax ($800,000/5 )
125,000
Earning After Tax ( EBT x 0.66)
82,500
Add: Depreciation
160,000
Cash Flow After Tax
242,500
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