Kinky Copies is considering the purchase of a high-volume copier. The machine co
ID: 2742529 • Letter: K
Question
Kinky Copies is considering the purchase of a high-volume copier. The machine costs $100,000 and will be depreciated straight-line over 5 years to a salvage value of $20,000. Kinky anticipates that the machine can actually be sold in 5 years for $30,000. The machine will save Kinky $20,000 a year in labor costs, but will require an increase in working capital, mainly paper supplies, of $10,000. The firm’s marginal tax rates is 35%, and the discount rate is 8%. a) What are the relevant capital investment cash flows for this purchase? b) What are the relevant cash flows related to changes in working capital for this purchase? c) What are the operating cash flows generated from this purchase? d) Compute the NPV for this purchase and advise Kinky Copies whether it should buy the machine?
Please show how to use BA II Plus financial calculator
Explanation / Answer
Solution A
Capital investment cash flow = cost of copier
= -100,000
Solution B
Working capital cash flow = changes in working capital
= -10,000
Solution C
Annual depreciation = (capital cost- salvage value)/ life
= (100,000-20,000)/5
= 16,000
Operating cash flow = Cost saving x (1- tax rate) + depreciation x tax rate
= 20,000 x (1-0.35) + 16,000 x 0.35
= 13000+5600
= 18,600
Solution D
Net salvage value = market value – (mkt value – salvage value) x taxrate
= 30,000 – (30000-20000) x 0.35
= 26,500
Calculation of NPV
NpV is the sum of present value of all cash flows. PVs are calculated by multiplying cash flows with PV factor:
Year
Cash flow
PV factor 8%
PV
0
-110000
1
-110000
1
18600
0.925926
17222.22
2
18600
0.857339
15946.5
3
18600
0.793832
14765.28
4
18600
0.73503
13671.56
5
18600
0.680583
12658.85
5
26500
0.680583
18035.45
-17700.14
NPV of the copier machine is -17,700.14
Year
Cash flow
PV factor 8%
PV
0
-110000
1
-110000
1
18600
0.925926
17222.22
2
18600
0.857339
15946.5
3
18600
0.793832
14765.28
4
18600
0.73503
13671.56
5
18600
0.680583
12658.85
5
26500
0.680583
18035.45
-17700.14
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