A new machine’s price is $50,000 plus an additional $10,000 for shipping and ins

Question

A new machine’s price is $50,000 plus an additional $10,000 for shipping and installation. The machine falls into the MACRS three year class, and hence the tax depreciation allowances are .33, .45 and .15 in Years 1, 2 and 3 respectively. The machine will be sold at the end of three years for $20,000. The machine will have no effect on revenues, but will save $20,000 per year in before-tax operating costs. The firm’s tax rate is 40 percent and its appropriate cost of capital is 10%. What is the Net Present Value of the project, should it be accepted?

Explanation / Answer

Cost of the new machine = Machine price + shipping & installation cost = $50000 + $10000 = $60000 Depreciation as per MACRS three years Year Depreciation rate Depreciation 1 0.33 $19,800.00 2 0.45 $27,000.00 3 0.15 $9,000.00 Calculation of Net operating cash flow Year Cost saving Depreciation Net saving Tax @ 40% Cost saving after tax Depreciation Net operating cash flow A B C = A-B D E = C - D F E + F 1 $20,000.00 $19,800.00 $200.00 $80.00 $120.00 $19,800.00 $19,920.00 2 $20,000.00 $27,000.00 -$7,000.00 -$2,800.00 -$4,200.00 $27,000.00 $22,800.00 3 $20,000.00 $9,000.00 $11,000.00 $4,400.00 $6,600.00 $9,000.00 $15,600.00 Negative tax amount means tax saving Calculation of NPV of the project at discount factor of 10% Year Cash flow PV factor @ 10% Present Value 0 -$60,000 1 -$60,000 1 $19,920 0.909090909 $18,109 2 $22,800 0.826446281 $18,843 3 $15,600 0.751314801 $11,721 Salvage value $20,000 0.751314801 $15,026 Net present value $3,699 As NPV of the project is positive figure , the project should be accepted.

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