You are evaluating two machines. Machine I costs $240,000 and it has a three-yea
ID: 2785764 • Letter: Y
Question
You are evaluating two machines. Machine I costs $240,000 and it has a three-year life. It has pre- tax operating costs of $60,000 per year. Machine Il costs $450,000 and it has a five-year life. It has pre-tax operating costs of $40,000 per year. For both machines, we use straight-line depreciation to zero over the machine's life. The pre-tax salvage value of Machine I is $50,000 at the end of its life. The pre-tax salvage value of Machine II is $150,000 at the end of its life. The marginal tax rate is 30% and the appropriate discount rate is 10%. (1) What is the NPV of investing in each machine? (12 points)Explanation / Answer
Machine 1:
Initial cost = 240,000
Pre-tax OC = 60,000
After-tax OC = 60,000*0.7 = 42,000
Annual depreciation = 240,000/3 = 80,000
Annual tax-saving on depreciation = 80,000*0.3 = 24,000
End book value = 0
End salvage value = 50,000
After-tax salvage value = 50,000 – (50,000 – 0)*0.3 = 35,000
NPV = -240000 - (42000/0.1)*(1 - 1/1.1^3) + (24000/0.1)*(1 - 1/1.1^3) + 35000/1.1^3
NPV = -258,467.32
Machine 2:
Initial cost = 450,000
After-tax OC = 40,000*0.7 = 28,000
Annual tax-saving on depreciation = (450,000/5)*0.3 = 27,000
After-tax salvage value = 150,000 - (150,000 - 0)*0.3 = 105,000
NPV = -450,000 - (28000/0.1)*(1 - 1/1.1^5) + (27000/0.1)*(1 - 1/1.1^5) + 105000/1.1^5
NPV = -388,594.05
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