Finance.com is considering the purchase of a new machine which will reduce manuf

Question

Finance.com is considering the purchase of a new machine which will reduce manufacturing and operating costs by $5,000 annually and increase revenues by $6,000 annually. Depreciation and taxes are excluded. Finance.com will use the MACRS method to depreciate the machine, and it expects to sell the machine at the end of its 5-year operating life for $10,000 before taxes. The 5-year MACRS depreciation rates are 20%, 32%, 19%, 12%, 12%, and 5%. Finance.com's marginal tax rate is 35 percent, and uses a 12 percent cost of capital to evaluate projects of this type. (a) If the machine's cost is $40,000 (including set up costs), what is the project's NPV? There are no other relevant cash flows. (18 points). Answer:

Explanation / Answer

Net Present Value is $ 2,960

Workings:

Step-1:Present value of annual cash flows Year 1 2 3 4 5 Total Reduction in operating cost $          5,000 $          5,000 $         5,000 $         5,000 $         5,000 Increase in revenue $          6,000 $          6,000 $         6,000 $         6,000 $         6,000 Total Income (a) $        11,000 $       11,000 $       11,000 $       11,000 $       11,000 Depreciation $          8,000 $       12,800 $         7,600 $         4,800 $         4,800 Total expenses (b) $          8,000 $       12,800 $         7,600 $         4,800 $         4,800 Income before Tax (a)-(b) $          3,000 $        -1,800 $         3,400 $         6,200 $         6,200 Less:Tax expenses $          1,050 $            -630 $         1,190 $         2,170 $         2,170 Net Income $          1,950 $        -1,170 $         2,210 $         4,030 $         4,030 Add:Depreciation $          8,000 $       12,800 $         7,600 $         4,800 $         4,800 Cash flows $          9,950 $       11,630 $         9,810 $         8,830 $         8,830 Discount factor              0.893              0.797 0.712 0.636 0.567 Present Value $          8,884 $          9,271 $         6,983 $         5,612 $         5,010 $ 35,760 Working: Depreciation shedule: Year Cost Depreciation Rate Depreciation Expenses Accumulated Depreciation Ending Book Value a b c=a*b d a-d 1 $        40,000 20% $         8,000 $    8,000 $ 32,000 2 $        40,000 32% $       12,800 $ 20,800 $ 19,200 3 $        40,000 19% $         7,600 $ 28,400 $ 11,600 4 $        40,000 12% $         4,800 $ 33,200 $    6,800 5 $        40,000 12% $         4,800 $ 38,000 $    2,000 Step-2:Present Value of after tax cash flows from sale of assets After ax cash flows = Sales Proceeds-((Sale Proceeds-Book Value)*Tax Rate) = 10000-((10000-2000)*35%) = $ 7,200 Step-3:Calculation of Net Present Value Present Value of annual cash flow $       35,760 Present value of after tax sale $          7,200 Total Present Value of Cash flow $       42,960 Less:Initial Invesment $       40,000 Net Present Value $          2,960

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