Rocky Mountain Lumber, Inc., is considering purchasing a new wood saw that costs

Question

Rocky Mountain Lumber, Inc., is considering purchasing a new wood saw that costs $70,000. The saw will generate revenues of $100,000 per year for five years. The cost of materials and labor needed to generate these revenues will total $60,000 per year, and other cash expenses will be $10,000 per year. The machine is expected to sell for $2,100 at the end of its five-year life and will be depreciated on a straight-line basis over five years to zero. Rocky Mountain’s tax rate is 34 percent, and its opportunity cost of capital is 15.40 percent. What is the project's NPV? (Do not round intermediate calculations. Round final answer to the nearest whole dollar, e.g. 5,275.) Should the company purchase the saw?

Explanation / Answer

NPV of the project is $ 12,108

Yes, due to positive NPV, saw could be purchased.

Working:

Calculation of NPV of the project: Years 1 2 3 4 5 Total cost of machine 70000 Revenue 100000 100000 100000 100000 100000 Salvage value 2100 Useful life(years) 5 Less: Cost: Cost of material and labour 60000 60000 60000 60000 60000 depreciation (Straight line) 13580 Other cash expenses 10000 10000 10000 10000 10000 Depreciation 13580 13580 13580 13580 13580 Income before tax 16420 16420 16420 16420 16420 Less: Tax @34% 5583 5583 5583 5583 5583 Net income 10837 10837 10837 10837 10837 Add: Depreciation 13580 13580 13580 13580 13580 Cash flow 24417 24417 24417 24417 24417 Discount factor (15.40%) 0.867 0.751 0.651 0.564 0.489 Present value 21159 18335 15888 13768 11931 81081 Present value of salvage 2100*.489 1027 Total of present value of cash inflow 82108 Less: Initial outlay 70000 NPV 12108

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