Bottoms Up Diaper Service is considering the purchase of a new industrial washer

Question

Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $1,800 and sell its old washer for $600. The new washer will last for 6 years and save $500 a year in expenses. The opportunity cost of capital is 19%, 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.)

  

c. What is NPV if the firm uses MACRS depreciation with a 5-year tax life? Use the MACRS depreciation schedule. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Explanation / Answer

a) We have to find out operating cash flow(OCF)

OCF = [(Revenues – Cash expenses) × (1 – Tax rate)] + (Tax rate × Depreciation)

Here, Revenues = 0, Cash expenses = 500, Tax rate = 0.40, Depreciation = 1800/6 = 300

OCF = {[$0 – (–$500)] × (1 – .40)} + [.40× 300]

OCF = $ 420

b) As we know that NPV = Cash Inflow - Initial Investment

Cash inflow = OCF × PVIFA + Post tax sales price of old washer

Cash inflow = $420 × ((1 / .19) – {1 / [.19(1 + .19)6]}) + 600 – [.40 × ($600 – 0)

   Cash inflow = $ 1792.11

Cash outflow = cost of washer = $1800

So, NPV = 1792.11 - 1800 = -7.89

c) Incremental cash flow in each year (using the depreciation tax shield approach) is: [$500 × (1 – .40)] + (Depreciation × .40)

Based on this NPV shall be as follows:-

By putting the above formulae NPV = 39.40

Year Depreciation Cash flow 0 o -1440 1 360 444 2 576 530.40 3 345.60 438.24 4 207.36 382.94 5 207.36 382.94 6 103.68 341.47

Related Questions

Navigate

• Browse (All)
• Browse B
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.