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 $1,800 and sell its old washer for $500. The new washer will last for 6 years and save $500 a year in expenses. The opportunity cost of capital is 18%, 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 1 to 6? The new washer will in fact have zero salvage value after 6 years, and the old washer is fully depreciated. Annual operating cash flow $

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.) NPV $

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.) NPV $

Explanation / Answer

a) and b)

C)

Time line 0 1 2 3 4 5 6 Cost of equipment -1800 +selling price of old eqp. 500 -taxes*(selling price - book value) For old equipment -200 =Initial Investment outlay -1500 Savings 500 500 500 500 500 500 -Depreciation Cost of equipment/6 -300 -300 -300 -300 -300 -300 = 200 200 200 200 200 200 -taxes =(savings- depreciation)*(1-tax) 120 120 120 120 120 120 +Depreciation 300 300 300 300 300 300 =after tax operating cash flow 420 420 420 420 420 420 Total Cash flow for the period -1500 420 420 420 420 420 420 Discount factor =(1+discount rate)^n 1 1.18 1.3924 1.643032 1.938778 2.287758 2.699554 Discount rate= 18% Discounted cash flows -1500 355.9322 301.6375 255.625 216.6313 183.5859 155.5812 NPV= Sum of discounted cash flows -31.0069

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