Kinky Copies may buy a high-volume copier. The machine costs $30,000 and will be

Question

Kinky Copies may buy a high-volume copier. The machine costs $30,000 and will be depreciated straight-line over 5 years to a salvage value of $5,000. Kinky anticipates that the machine actually can be sold in 5 years for $12,000. The machine will save $5,000 a year in labor costs but will require an increase in working capital, mainly paper supplies, of $2,500. The firm’s marginal tax rate is 35%, and the discount rate is 10%. (Assume the net working capital will be recovered at the end of Year 5.)

Calculate the NPV. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.) NPV $ Should Kinky buy the machine? Yes No

Explanation / Answer

Step- 1 Calculation of Initial Investments

Machine cost $ 30000

Initial Investments $ 2500

Total Investment   $ 32500

Step-2 Calculation of post tax salvage value

A. Expected Salvage value at the end of 5 years = $ 12000

B. Book value = $ 5000

Therefore, Capital gain (A-B) = $ 7000

C. capital gain tax @35% = $ 2450

D. post tax salveage value (A- C) = $ 9550

E. PV of  post tax salveage value = $ 5929.80

Step- 3 Calculation of Depreciation Tax Shield

Depreciation each year = (cost- salvage value) / useful life

= (30000-5000) / 5

= $ 5000

Tax shield on Depreciation = $1750 each year end

Therefore PV of DTS = $ 6633.88

Step-4 Calculation of PV of Annual Savings $ Recoverey of Working capital

Annual Savings = $ 5000 ; Working capital = $ 2500

PV of Annual Savings & Working capital = $ 18953.93 + 1552.30 = $ 20506.23

Therefore, NPV (4+3+2-1) = ($ 11289.69)

Since the NPV is negative the Kinky should not buy the machine.

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