Oxygen Optimization is considering buying a new, high efficiency purification sy

Question

Oxygen Optimization is considering buying a new, high efficiency purification system. The new system would be purchased today for 14,800 dollars. It would be depreciated straight-line to 2,200 dollars over 2 years. In 2 years, the system would be sold and the after-tax cash flow from capital spending in year 2 would be 2,900 dollars. The system is expected to reduce costs by 4,600 dollars in year 1 and by 12,900 dollars in year 2. If the tax rate is 50 percent and the cost of capital is 10.9 percent, what is the net present value of the new purification system project?

Explanation / Answer

Depreciation = (14800-2200)/2 = 6300

Present value of cash flow = (PVF@10.9%, 1*CF1 ) + (PVF@10.9%,2*CF2)+(PVF@10.9%,2 *After tax value)

                        = (.90171 *5450)+(.81309*9900 )+(.81309 * 2900)

                          = 4914.32+ 8049.59+ 2357.96

                           = 15321.87

NPV = 15321.87 - 14800 = $ 521.87

year1 2 Revenue 4600 12900 less:Depreciation -6300 -6300 Income before tax -1700 6600 Tax -850    [1700*.50] 3300 Income after tax - 850 3300 Add:depreciation 6300 6300 Cash flow 5450 9900

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