Bottoms Up Diaper Service is considering the purchase of a new industrial washer

Question

Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $7,800 and sell its old washer for $1,600. The new washer will last for 6 years and save $2,300 a year in expenses. The opportunity cost of capital is 17%, and the firm’s tax rate is 40%.

What is NPV if the firm uses MACRS depreciation with a 5-year tax life? Use the MACRS depreciation schedule.

Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $7,800 and sell its old washer for $1,600. The new washer will last for 6 years and save $2,300 a year in expenses. The opportunity cost of capital is 17%, and the firm’s tax rate is 40%.

What is NPV if the firm uses MACRS depreciation with a 5-year tax life? Use the MACRS depreciation schedule.

Explanation / Answer

Computation of NPV of the Washer (Uses the MACRS depreciation with 5-years): NPV = $758.33

Notes:
Calculation = {(Savings in expenses - depreciation) - tax} + depreciation = Cash flows

Year- 1 ={(2,300 - 1,560) - 40%} + 1,560 = 2,004  
Year- 2 =(2,300 - 2,496) = -193 loss + 2,496 = 2,300
Year- 3 ={(2,300 - 1,497.60) - 40%} + 1,497.60 = 1,979.04
Year- 4 ={(2,300 - 898.56) - 40%} + 898.56 = 1,739.42
Year- 5 ={(2,300 - 898.56) - 40%} + 898.56 = 1,739.42  
Year- 6 ={(2,300 - 449.28) - 40%} + 449.28 = 1,559.71

Depreciation Calculation:

Year- 1 = 7,800 * 20% = 1,560
Year- 2 = 7,800 * 32% = 2,496
Year- 3 = 7,800 * 19.2% = 1,497.60
Year- 4 = 7,800 * 11.52% = 898.56
Year- 5 = 7,800 * 11.52% = 898.56
Year- 6 = 7,800 * 5.76% = 449.28

year cash flows Discounting factor @ 17% Present value calculation Cash flow 0 -7,800 + 1,600 -6,200 1 -6,200 1 Notes given below 2,004   1 / (1+17%)1 = 0.8547 1,712.82 2 Notes given below 2,300 1 / (1+17%)2 = 0.7305 1,680.15 3 Notes given below 1,979.04 1 / (1+17%)3 = 0.6244 1,235.71 4 Notes given below 1,739.42 1 / (1+17%)4 = 0.5337 928.33 5 Notes given below 1,739.42 1 / (1+17%)5 = 0.4561 793.35 6 Notes given below 1,559.71 1 / (1+17%)6 = 0.3898 607.97 NPV: = sum of all present value of cash flows $758.33

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