Flatte Restaurant is considering the purchase of a $10,600 soufflé maker. The so

Question

Flatte Restaurant is considering the purchase of a $10,600 soufflé maker. The soufflé maker has an economic life of five years and will be fully depreciated by the straight-line method. The machine will produce 2,300 soufflés per year, with each costing $2.70 to make and priced at $5.55. Assume that the discount rate is 16 percent and the tax rate is 40 percent.

What is the NPV of the project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) NPV $

Should the company make the purchase? No Yes

Explanation / Answer

NPV = P.V. of cash inflow - P.V. of cash outflow

1) P.V. of cash inflow is calculated as follows:-

Sales (2300 * 5.55)

(-) Cost excluding depreciation (2300 * 2.70)

12765

6210

Profit before depreciation

(-) Depreciation [10600 / 5]

6555

2120

Profit before tax

(-) Tax @ 40 %

4435

1774

Profit after tax

(+) Depreciation

2661

2120

P.V. of cash inflow = Operating cash inflow * Cumulative P.V. factor for 5 years @ 16 %

   = 4781 * 3.2743

= $ 15654.43 (approx)

P.V. of cash outflow = $ 10600

NPV of Project = 15654.43 - 10600 = $ 5054.43 (approx)

Conclusion:- The NPV of project is $ 5054.43. As the NPV of the project is positive, thus the project should be accepted. In other words, company should make the purchase of souffle maker.

Sales (2300 * 5.55)

(-) Cost excluding depreciation (2300 * 2.70)

12765

6210

Profit before depreciation

(-) Depreciation [10600 / 5]

6555

2120

Profit before tax

(-) Tax @ 40 %

4435

1774

Profit after tax

(+) Depreciation

2661

2120

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