Bottoms Up Diaper Service is considering the purchase of a new industrial washer
ID: 2731731 • Letter: B
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 $600. The new washer will last for 6 years and save $500 a year in expenses. The opportunity cost of capital is 19%, 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. b) what is the 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.)
Explanation / Answer
Requirement a:
Initial Cash Flow:
Cost of New washer = -$1800
Sale of old washer = $600
Net Cash Outflow = $1200
Recurring Cash Flows:
Depreciation under straight line method
= Cost / Useful life
= $1800 / 6
= $300
Particulars
Amount
Savings in expenses
$500
Less: Taxes (40%)
-$200
Savings after tax
$300
Add: Tax Shield on Depreciation (300 * 40%)
$120
Cash Flow after tax
$420
Calculation of NPV:
Year
Cash Flow
PVF (19%)
PV of Cash Flow
0
-$1200
1
-$1200
1-6
$420
3.4098
$1432.116
$232.116
NPV = $232.12
Requirement b:
Initial Cash Flow:
Cost of New washer = -$1800
Sale of old washer = $600
Net Cash Outflow = $1200
Recurring Cash Flows:
Depreciation as per MACRS Method:
Year
Calculation
Depreciation
Tax Shield on depreciation
1
1800 * 20%
360
144
2
1800 * 32%
576
230.40
3
1800 * 19.2%
345.6
138.24
4
1800 * 11.52%
207.36
82.944
5
1800 * 11.52%
207.36
82.944
6
1800 * 5.76%
103.68
41.472
Particulars
Amount
Savings in expenses
$500
Less: Taxes (40%)
-$200
Savings after tax
$300
Cash Flow after tax:
Year
Savings after Tax
Tax Shield on depreciation
Cash Flow After Tax
1
$300
$144
$444
2
$300
$230.40
$530.40
3
$300
$138.24
$438.24
4
$300
$82.944
$382.944
5
$300
$82.944
$382.944
6
$300
$41.472
$341.472
Calculation of NPV:
Year
Cash Flow
PVF (19%)
PV of Cash Flow
0
-$1200
1
-$1200
1
$444
0.8403
$373.0932
2
$530.40
0.7062
$374.56848
3
$438.24
0.5934
$260.051616
4
$382.944
0.4987
$190.9741728
5
$382.944
0.4190
$160.453536
6
$341.472
0.3521
$120.2322912
$279.373296
NPV = $279.37
Particulars
Amount
Savings in expenses
$500
Less: Taxes (40%)
-$200
Savings after tax
$300
Add: Tax Shield on Depreciation (300 * 40%)
$120
Cash Flow after tax
$420
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