You are contemplating the purchase of a new $1,840,000 computer-based dairy cow

Question

You are contemplating the purchase of a new $1,840,000 computer-based dairy cow feeding system. The system will be depreciated straight-line over its ten year life and have no value at the end of its life. you will earn $530,000 before taxes per year from additional milk production. If the tax rate is 25% and the required return to capitol is 10% compute the following-on an after-tax basis.

a) What is the annual after-tax cash flow?

b) What is the value of the depreciation tax shield?

c) Compute the Net Present Value.

d) How much would you be willing to pay at most for this feeding system?

Explanation / Answer

(a) Annual cash flow after-tax = $530000 – $132500 = $397500.

(b) The value of the depreciation tax shield = 1840000 / 10 = $184000 x 25/100 = $46000

(c)

Years

Cash Inflow

Present value of $1

Present Value of Cash Inflow

1

397500

.909

361327.5

2

397500

.826

328335

3

397500

.751

298522.5

4

397500

.683

271492.5

5

397500

.621

246847.5

6

397500

.564

224190

7

397500

.514

204315

8

397500

.466

185235

9

397500

.424

168540

10

397500

.385

153037.5

Total

2441842.5

Net Present Value = 2441842.5 – 1840000 = $601842.5

(d) We will be willing to pay at most for this feeding system $ 2441842.5 and now we can purchase this at $1,840,000.

Years

Cash Inflow

Present value of $1

Present Value of Cash Inflow

1

397500

.909

361327.5

2

397500

.826

328335

3

397500

.751

298522.5

4

397500

.683

271492.5

5

397500

.621

246847.5

6

397500

.564

224190

7

397500

.514

204315

8

397500

.466

185235

9

397500

.424

168540

10

397500

.385

153037.5

Total

2441842.5

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