CORPORATE FINANCE All calculation up to four decimal points Your company is cons

Question

CORPORATE FINANCE All calculation up to four decimal points Your company is considering buying a machine to automate a process and make a cost saving of $700,000 a year. The machine costs S2.000.000 that can be amortized linearly to zero (no salvage value) over the life of the machine which is 5 years. It costs S40.000 a year to operate the machine. The discount rate of the project is 8% which is the same as the cost of borrowing. Your company decides to borrow the money at 8% with payments being made annually. What are the annual payments such that the loan is paid off in 5 years? What is the total interest that is paid over the life of the loan? If the company's tax rate is 2.5%, what is the NPV of this project? What is the minimum cost savings that would justify purchasing the machine?

Explanation / Answer

the annual payment required to pay off the loan in 5 years

2000000 = Annuity * PVIFA ( r%, n)

2000000 = Annuity * PVIFA(8%,5)

Annuity = 500912

The total interest paid = total annuity - loan amount

= 500912 * 5 - 2000000 = 504564

The NPV of the project = PV of Cash inflow - PV of cash outflow

                                 = PV of (700000 - 40000)*(1 - 2.5%) - 2000000

                                 = 2569308 - 2000000 = 569308

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