Question

Dorothy & George Company is planning to acquire a new machine at a total cost of $38,700. The machine’s estimated life is 6 years and its estimated salvage value is $600. The company estimates that annual cash savings from using this machine will be $11,100. The company’s after-tax cost of capital is 7% and its income tax rate is 40%. The company uses straight-line depreciation. (Use Appendix C, Table 1 and Appendix C, Table 2.) (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign. Round answers to the nearest dollar amount.)

Required: 1. What is this investment’s net after-tax annual cash inflow? 2. Assume that the net after-tax annual cash inflow of this investment is $6,000; what is the net present value (NPV) of this investment? 3. What are the minimum net after-tax annual cost savings that make the proposed investment acceptable (i.e., the dollar cost savings that would yield an NPV of $0)? Hint: Redo the NPV analysis by setting the NPV equal to zero and making the annual after-tax cash flows equal to X; then solve for X and enter the amount as your answer. Also consider using Goal Seek in Excel.

Answer 1

Sollution 1

Annual cash flows = (Cash savings – Depreciation)(1-Tax Rate) + Depreciation

={ ($11100 – $6350)(1-40%)+$6350}

=$9200

Sollution 2

Computation of NPV
Particulars	Period	PV Factor (7%)	Amount	Present Value
Cash outflows:
Initial investment	0	1	$38,700.00	$38,700.00
Present Value of Cash outflows (A)				$38,700.00
Cash Inflows
Annual cash inflows	1-6 years	4.76654	$6,000.00	$28,599.00
Salvage Value	6th year	0.666342	$600.00	$400.00
Present Value of Cash Inflows (B)				$28,999.00
Net Present Value (NPV) (B-A)				($9,701)

Sollution 3

Minimum net after-tax annual cost savings = ($38700-$400)/4.76654 = $8035.17