A company is evaluating a continuous baking oven. New oven would cost $685,000,

Question

A company is evaluating a continuous baking oven. New oven would cost $685,000, including cost of equipment, shipping and installation. No increase in capcity with new oven, however operating expenses would be reduced by $105,000. 7 year MACRS schedule to a value of zero will be used, however the oven can be sold in year 10 for $30,000. Cost will increase by 5% per year over the 10 year economic life. Given partial balance sheet: Current liabilities= $1,000,000; Mortage Bond= $5,143,000; Common Stock(500,000 shares)= $500,000; Contributed capital in excess of par= 2,000,000; Retained earnings= $8,640,210; total liablities and common equity= $17,283,210 Cost of capital= 11.27% Tax Rate= 35% What is the NPV of the oven???

Explanation / Answer

Assuming Operating Expense saving does not include depreciation   The cost increases by 5% , so assuming savings reduced by 5% each year Years MACRS Rate Investment Saving in Operating Cost Depreciation Salvage Taxable Income Tax@35% Post Tax income Add Back Depreciation Net Cash Flow PV Factor@11.27% PV of Cash flows Yr 0 (685,000)                 1 (685,000)          1 14.29%     105,000     (97,887)        7,114      (2,490)          4,624      97,887    102,510         0.899        92,128          2 24.49%       99,750 (167,757) (68,007)      23,802     (44,204)    167,757    123,552         0.808        99,792          3 17.49%       94,763 (119,807) (25,044)        8,765     (16,279)    119,807    103,528         0.726        75,149          4 12.49%       90,024     (85,557)        4,468      (1,564)          2,904      85,557      88,461         0.652        57,708          5 8.93%       85,523     (61,171)      24,353      (8,523)       15,829      61,171      77,000         0.586        45,144          6 8.92%       81,247     (61,102)      20,145      (7,051)       13,094      61,102      74,196         0.527        39,094          7 8.93%       77,185     (61,171)      16,014      (5,605)       10,409      61,171      71,580         0.474        33,896          8 4.46%       73,325     (30,551)      42,774    (14,971)       27,803      30,551      58,354         0.426        24,834          9       69,659                 -        69,659    (24,381)       45,278                -        45,278         0.382        17,318        10       66,176                 -      30,000      96,176    (33,662)       62,515                -        62,515         0.344        21,488 (178,450) NPV = $-178,450

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