Bottoms Up Diaper Service is considering the purchase of a new industrial wosher
ID: 2790751 • Letter: B
Question
Bottoms Up Diaper Service is considering the purchase of a new industrial wosher. It can purchase the washer for $7.500 and sell its old washer for $2000. The new washer will last for 6 years and save $2000 a year in expenses. The opportunity cost of capital is 16%, and the firm's tax rate is 40% a. If the firm uses straight -line depreciation to an assumed salvage value of zero over a 6-year life, what is the annual operating cash flow of the project in years 1 to 6? The new washer will in fact have zero salvage value,after 6 years, and the old washer is fully depreciated operating cash flow b. What is project NPV? (Negative amount should be indicated by a minus sign. Do not round intermediate calculetions. Round your answer to 2 decimel places) NPV e. What is NPV if the firm uses MACRS depreciation intermediate calculations. Round your a n with a S-year tax life? Use the MACRS depreciation schedule. (Do not round nswer to 2 decimal places.)Explanation / Answer
a)
Annual Operating Cash Flow
Annual Savings
$2,000
Less: Depreciation
$1,250
Add: Tax saved on depreciation
$500
Annual Operating Cash Flow
$3,750
b) Formula for NPV: NPV = R x {[1 – (1+i)-n] / i} – Initial Investment
R is the Annual operating cash flow;
i is the required rate of return per period; (In this case, it will be opportunity cost of capital)
n is life in years.
Initial investment = Cost of new washer – After-tax value of old washer
After-tax value of old washer = Market value of washer * (1-tax rate)
(Note: When market value of an equipment is higher than its book value, tax is levied on the amount over book value when equipment is sold)
Initial investment => $7,500 – [$2,000*(1-0.4)]
=> $7,500 - $1,200
= $6,300
NPV = $3,750*{[1 – (1+0.16)-6] / 0.16} – $6,300
=> ($3,750*3.684735908) - $6,300
=> $13,817.76 - $6,300
= $7,517.76
c) Annual operating cash flow with MACRS depreciation with 5-year tax life:
Year
1
2
3
4
5
6
Annual Savings
$2,000
$2,000
$2,000
$2,000
$2,000
$2,000
Less: Depreciation
$1,500
$2,400
$1,440
$864
$864
$432
Add: Tax saved on depreciation
$600
$960
$576
$346
$346
$173
Annual Operating Cash Flow
$4,100
$5,360
$4,016
$3,210
$3,210
$2,605
Formula for NPV: -Initial investment + [(Cash Inflow1)/(1+r)1] + [(Cash Inflow2)/(1+r)2] + [(Cash Inflow3)/(1+r)3]…..+ [(Cash Inflown)/(1+r)n]
NPV = {$4,100/(1+.16)1} + {$5,360/(1+.16)2} + {$4,016/(1+.16)3} + {$3,210/(1+.16)4} + {$2,605/(1+.16)5} - $6,300
=> $3,534.48 + $3,983.35 + $2,572.88 + $1,772.63 + $1,528.13 + $1,069.12 - $6,300 = $8,160.60
Annual Operating Cash Flow
Annual Savings
$2,000
Less: Depreciation
$1,250
Add: Tax saved on depreciation
$500
Annual Operating Cash Flow
$3,750
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