Your CEO is considering purchasing manufacturing equipment that falls under the

Question

Your CEO is considering purchasing manufacturing equipment that falls under the three- MACRS category. The cost of new equipmant is $200,000. Earnings before depreciation and taxes for the next 4 years will be:

year 1....$90,000

Year 2...105,000

Year 3....85,000

Year 4...35,000

The firm is in a 30% tax bracket and has a 12% cost of capital.

Should she purchas the new equipmant?

Determine the annual cash flow for each year.

Determine present value for cash flows

(book being used is Foundations of Financial management 12th edition

Explanation / Answer

annual cash flow=
yaer 1
Depreciation= 200000*33.33%=66660
cash flow= 90000-66660*(1-0.30)= 16338
Cash flow=16338+66660=82998

yaer 2
Depreciation= 133340*44.45%= 59269.63
cash flow= 105000-59269.63*(1-0.30)= 32011.259
cash flow= 32011.259+59269.63=91280.889

year 3
Depreciation= 74070.37*14.81%=10969.8
cash flow = 85000-10969.8*(1-0.30)=51821.14
Cash flow=51821.14+10969.8=62790.94

year 4
Depreciation = 63100.57*7.41%=4675.75
Cash flow= 35000-4675.75*(1-0.30)= 21226.975
Cash flow=21226.975+4675.75=25902.725

Present value of cash flows=
year1=82998*0.893 = 74117.214
year 2= 91280.889*0.797 = 72750.868533
year 3= 62790.94*0.712=44707.14928
year4 = 25902.725*0.635= 16448.230375

NPV=200000-(74117.214+72750.868533+44707.14928+16448.230375)=8028.9238

As, NPV is positive she should purchase the equipment....

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