Bottoms Up Diaper Service is considering the purchase of a new industrial washer
ID: 2819058 • Letter: B
Question
Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $7,200 and sell its old washer for $2,500. The new washer will last for 6 years and save $1,700 a year in expenses. The opportunity cost of capital is 15%, 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 0 to 6? The new washer will in fact have zero salvage value after 6 years, and the old washer is fully depreciated. (Negative amount should be indicated by a minus sign.)
b. What is project NPV? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)
Explanation / Answer
a.
Cost of new washer = $ 7,200
After tax sales value of old washer = $ 2,500 – ($ 2,500 x 0.4)
= $ 2,500 x 0.6 = $ 1,500
Initial investment = Cost of new washer - After tax sales value of old washer
= $ 7,200 - $ 1,500 = $ 5,700
Straight line annual depreciation of washer = Purchase cost/useful life = $ 7,200/6 = $ 1,200
Annual operating cash flow = (Revenue as cost savings) x (1 – tax rate) + (tax rate x Depreciation)
= $ 1,700 x (1 – 0.4) + (0.4 x $ 1,200)
= $ 1,700 x 0.6 + 0.4 x $ 1,200
= $ 1,020 + $ 480 = $1,500
Cash flow in year 0 is - $ 5,700.
Annual operating cash flow of the project in year 1 through 6 is $ 1,500
b.
NPV = C x PVIFA (i, n) – initial investment
C = Annual cash flow = $ 1,500
i = Rate of interest = 15 %
n = No. of periods = 6
NPV = $ 15,000 x PVIFA (15 %, 6) - $ 5,700
= $ 15,000 x 3.7845 - $ 5,700
= $ 5,676.75 - $ 5,700
= - $ 23.25
NPV of the project is - $ 23.25
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