Bayleaf Inc. is considering the purchase of a machine that costs $200,000. Insta

Question

Bayleaf Inc. is considering the purchase of a machine that costs $200,000.

Installation costs are $20,000 which are going to be deemed an “expense” when the installation is done

The machine is expected to generate additional revenues of $150,000 per year for four years while incurring annual operating costs of $50,000 a year.

The machine would be depreciated for tax purposes using the straight-line method over the life of the asset and will utilize a $30,000 salvage value in the calculation of depreciation expense

It is expected that we would received $40,000 upon the sale of the equipment at the end of its life.

At the end of two years of operations the Company will have to pay $10,000 for an overhaul of the machine which would be deemed an expense in the year paid

The Company considers the impact of income taxes in all of its capital investment decisions. The company has a 30% income tax rate

The Company desires an after-tax rate of return of 10% on its investment.

Required:     

List all the Cash flows associated with the NPV calculation of this problem.

Explain the payback period method

Explanation / Answer

INITIAL CASH FLOW

COST OF THE MACHINE = $200000

ADD INSTALATION COST = $20000

TOTAL INITIAL CASH FLOW = $220000

INBETWEEN CASH FLOW

TERMINAL CASH FLOW

SALVAGE VALUE TO BE RECEIVED = $40000

LESS BOOK VALUE = ($30000)

PROFIT ON SALE = $10000

LESS TAX @30% = ($3000)

NET CASH FLOW ($40000 - $3000) = $37000

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PAYBACK PERIOD

= INITIAL INVESTMENT / NET ANNUAL CASH FLOW

= $220000 / $82750

= 2.66 YEARS

DESCRIPTION AMOUNT ANNUAL REVENUE $150000 LESS ADDITIONAL COST ($50000) LESS DEPERICATION [($200000 - $30000) / 4YEAR] ($42500) NET INCOME BEFORE TAX $57500 LESS TAX @30% ($17250) NET INCOME AFTER TAX $40250 ADD DEPERICATION $42500 NET ANNUAL CASH FLOW $82750

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