Radar Railway is determining whether to purchase a new rail setter, which has a

Question

Radar Railway is determining whether to purchase a new rail setter, which has a base price of $432,000 and would cost another $52,000 to install. The setter falls into the MACRS 3-year class, and it would be sold after three years for 220,000. Using the setter requires a $22,000 increase in net working capital. Although it would have no effect on revenues the setter should save the firm $185,000 per year in before-tax operating costs (excluding depreciation). Radar’s marginal tax rate is 40% and its required rate of return is 14%. Should the setter be purchased? Explain.

Depreciation

Year 1 - $159,720

Year 2 - $217,800

Year 3 - $72,600

Explanation / Answer

SInce the NPV is negative, the setter should not be purchased

Year 0 1 2 3 Initial Cost -432000 Installtion Cost -52000 Increase in Working Capital -22000 Saving in revenue 185000 185000 185000 Less Depriciation 159720 217800 72600 Salvage Value 220000 Net Profit 25280 -32800 332400 Tax at 40% 10112 0 132960 Profit After Tax 15168 -32800 199440 Add back depriciation 159720 217800 72600 Total Operating profit -506000 174888 185000 272040 Disocunt factor at 14% 0.877192982 0.769467528 0.674971516 Discounted Cash Flow -506000 153410.53 142351.49 183619.25 Net Present Value -26618.73

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