Litchfield Design is evaluating a 3-year project that would involve buying a new
ID: 2732753 • Letter: L
Question
Litchfield Design is evaluating a 3-year project that would involve buying a new piece of equipment for 110,000 dollars today. The equipment would be depreciated straight-line to 10,000 dollars over 2 years. In 3 years, the equipment would be sold for an after-tax cash flow of 17,000 dollars. In each of the 3 years of the project, relevant revenues are expected to be 73,000 dollars and relevant costs are expected to be 23,000 dollars. The tax rate is 50 percent and the cost of capital for the project is 7.15 percent. What is the NPV of the project?Explanation / Answer
Annual depreciation = (cost of asset – salvage value)/ life
= (110,000 -10,000)/3
= 33,333.33
Depreciation tax shield = annual depreciation x tax rate
= 33,333.33 x 50%
= 16,666.67
Annual cash flow = (revenue – cost) x (1- tax rate) + depreciation tax shield
= (73000-23000) x (1- 0.50) + 16,666.67
= 41,666.67
Net salvage value = 17000
Now we will multiply the cash flows with PV factors and calculate NPV:
year
Cash flow
PV factor 7.15%
PV
0
-110000
1
-110000
1
41666.67
0.933271115
38886.3
2
41666.67
0.870994975
36291.46
3
41666.67
0.812874451
33869.77
3
17000
0.812874451
13818.87
12866.4
Hence, NPV would be 12,866.40
year
Cash flow
PV factor 7.15%
PV
0
-110000
1
-110000
1
41666.67
0.933271115
38886.3
2
41666.67
0.870994975
36291.46
3
41666.67
0.812874451
33869.77
3
17000
0.812874451
13818.87
12866.4
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