Management is considering purchasing an asset for $50,000 that would have a usef

Question

Management is considering purchasing an asset for $50,000 that would have a useful life of 5 years and no salvage value. For tax purposes, the entire original cost of the asset would be depreciated over 5 years using the straight-line method. The asset would generate annual net cash inflows of $20,000 throughout its useful life. The project would require additional working capital of $7,000, which would be released at the end of the project. The company's tax rate is 30% and its discount rate is 13%.

Required:
What is the net present value of the asset?

Explanation / Answer

NPV:

Initial cost = $50,000 + $7,000

                   = $57,000

         Net cash inflows before depreciation and tax = $20,000

                        Less: Depreciation ($50,000/5 years) = $10,000

Net cash inflows after depreciation but before tax = $10,000

                           Less: Tax at 30% ($10,000*30/100) = $3,000

                                              Net cash inflow after tax = $7,000

                                                Add back: Depreciation = $10,000

                        Annual cash inflows from the project = $17,000

6,595

Therefore, NPV of the asset is $6,595 (positive).

Year Cash in flows ($) (a) Present value factor at 13% (1/1.13) (b) Present value of cash outflows ($) (c = a*b) 0 -57,000 1 -57,000 1 17,000 0.8850 15045 2 17,000 0.7832 13314.4 3 17,000 0.6931 11782.7 4 17,000 0.6133 10426.1 5 17,000 0.5428 9227.6 5 7,000 0.5428 3799.6 NPV

6,595

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