Bottoms Up Diaper Service is considering the purchase of a new industrial washer

Question

Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $7,200 and sell its old washer for $2,100. The new washer will last for 6 years and save $1,700 a year in expenses. The opportunity cost of capital is 14%, and the firm’s tax rate is 40%.

a. If the firm uses straight-line depreciation to an assumed salvage value of zero over a 6-year life, what is the annual operating cash flow of the project in years 0 to 6? The new washer will in fact have zero salvage value after 6 years, and the old washer is fully depreciated. (Negative amount should be indicated by a minus sign.)

b. What is project NPV? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)

c. What is NPV if the firm uses MACRS depreciation with a 5-year tax life? Use the MACRS depreciation schedule. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Explanation / Answer

Annual savings in expenses 1700.00 Less: Depreciation (7200/6) 1200.00 Net savings before tax 500.00 Tax at 40% 200.00 Incremental NOPAT 300.00 Add: Depreciation 1200.00 Annual OCF 1500.00 PV of annual OCF = 1500*(1.14^6-1)/(0.14*1.14^6) = 5833.00 Less: Initial investment = 7200-2100*(1-0.40) = 5940.00 NPV -107.00 0 1 2 3 4 5 6 Annual savings in expenses 1700.00 1700.00 1700.00 1700.00 1700.00 1700.00 Depreciation 1440.00 1440.00 1440.00 1440.00 1440.00 1440.00 Net savings before tax 260.00 260.00 260.00 260.00 260.00 260.00 Tax at 40% 104.00 104.00 104.00 104.00 104.00 104.00 Incremental NOPAT 156.00 156.00 156.00 156.00 156.00 156.00 Add: Depreciation 1440.00 1440.00 1440.00 1440.00 1440.00 1440.00 Annual OCF 1596.00 1596.00 1596.00 1596.00 1596.00 1596.00 Capital expenditure: Cost of new industrial washer 7200.00 After tax salvage value of old industrial washer = 2100*(1-0.40) = -1260.00 Project cash flows -5940.00 1596.00 1596.00 1596.00 1596.00 1596.00 1596.00 PVIF at 14% 1 0.87719 0.76947 0.67497 0.59208 0.51937 0.45559 PV at 14% -5940.00 1400.00 1228.07 1077.25 944.96 828.91 727.12 NPV 266.31

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