Staples Business Solutions is considering the purchase of a high volume photocop
ID: 2717060 • Letter: S
Question
Staples Business Solutions is considering the purchase of a high volume photocopier. The new machine will cost $150,000 and will last for 5 years at which time it will have a salvage value of $35,000. The new machine will result in before-tax cost savings of $25,000 a year. It will however require an increase in working capital of $10,000. The new photocopier will belong to an asset class that has a CCA rate of 30%. The firm’s tax rate is 35% and the discount rate is 8%. Should Staples buy the new photocopier?Staples Business Solutions is considering the purchase of a high volume photocopier. The new machine will cost $150,000 and will last for 5 years at which time it will have a salvage value of $35,000. The new machine will result in before-tax cost savings of $25,000 a year. It will however require an increase in working capital of $10,000. The new photocopier will belong to an asset class that has a CCA rate of 30%. The firm’s tax rate is 35% and the discount rate is 8%. Should Staples buy the new photocopier?
Explanation / Answer
Answer:
The initial investment is $150,000 for the copier plus $10,000 in working capital, for a total outlay of $160,000.
Depreciation expense = ($150,000 - $35,000)/5 = $23,000 per year
The project saves $25,000 in before tax cost saving, so the net operating cash flow (including the depreciation tax shield) is:
$25,000 * (1 - 0.35) + ($23,000 * 0.35) = $24300
In addition, the working capital associated with the project is freed up, which releases another $10,000 in cash.
The NPV is thus:
NPV = -$160,000 + [$24300 ´ annuity factor(8%, 5 years)] + [$10000/(1.08)5]
= -$160,000 + 97022.61+6805.83 = -$-56171.56
Because NPV is negative, Staples’s should not buy the new copier.
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