A new operating system for an existing machine is expected to cost $770,000 and

Question

A new operating system for an existing machine is expected to cost $770,000 and have a useful life of six years. The system yields an incremental after-tax income of $295,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $18,600.

Compute the net present value of each potential investment. Assume the company requires a 10% rate of return on its investments. (FV of $1, PV of $1, FVA of $1and PVA of $1) (Use appropriate factor(s) from the tables provided.) Select Chart Cash Flow Annual cash flow Residual value Amount X PV FactorPresent Value Net present value

Explanation / Answer

Explanation ....... Income after tax is given so, we have add the depreciation to calculate the cash flow after tax. So cash flow = 295000 + 125233 = 420233

Depreciation = ( 770,000 - 18600) / 6 = 125233

For this PV factor = [ 1 - (1.10)-6 ] / 0.10 = 4.355261

PV for residual value = (1.10)-6 = 0.564474

Question - 2  

Annual cash flow Cash flow after tax 420233 X 4.355261 1830224 Residual value 18600 X 0.564474 10499.22 Total Present value 1840723 (-) Investment 770000 Net present value 1070723

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