3. Pique Corporation wants to purchase a new machine for $300,000. Management pr

Question

3.

Pique Corporation wants to purchase a new machine for $300,000. Management predicts that the machine can produce sales of $200,000 each year for the next 5 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $80,000 per year. The firm uses straight-line depreciation with no residual value for all depreciable assets. Pique's combined income tax rate is 40%. Management requires a minimum after-tax rate of return of 10% on all investments.

What is the net present value (NPV) of the investment? (The PV annuity factor for 5 years, 10% is 3.791.) Assume that the cash inflows occur at year-end.

Explanation / Answer

Income after tax = (Sales - Non-depreciation costs - Depreciation) x ( 1-t) = ( $ 200,000 - $ 80,000- $ 60,000) x 0.60 = $ 36,000

Annual cash flows = Income after tax + Depreciation = $ 36,000 + $ 60,000 = $ 96,000

Present value of cash inflows at discount rate of 10% = $ 96,000 x 3.7908 = $ 363,917

NPV = Present value of cash inflows - Initial investment = $ 363,917 - $ 300,000 = $ 63,917

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