Question

A new operating system for an existing machine is expected to cost $560,000 and have a useful life of six years. The system yields an incremental after-tax income of $175,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $28,800. A machine costs $450,000, has a $32,600 salvage value, is expected to last eight years, and will generate an after-tax income of $70,000 per year after straight-line depreciation. Assume the company requires a 12% rate of return on its investments. Compute the net present value of each potential investment. (PV of $1, FV of $1, PVA of $1, and FVA of $1) (Use appropriate factor(s) from the tables provided.)

Answer 1

I) Calculation of Depreciation

a) Machine A

= [(5,60,000 - 28,800)/6]

= 88,533

a) Machine B

= [(4,50,000 - 32,600)/8]

= 52,175

II) Calculation of Annual cash inflows

a) Machine A

= Net Profit + Depreciation

= 1,75,000 + 88,533

= 2,63,533

a) Machine B

= Net Profit + Depreciation

= 70,000 + 52,175

=1,22,175

III) Calculation of Net Present Value

a) Machine A

Items	years	amount of cash flow	12% factor	Present value of cash flow
annual cash inflow	1-6	2,63,533	4.112	10,83,648
initial Investment				(5,60,000)

Net Present Value 5,23,648

a) Machine B

Items	years	amount of cash flow	12% factor	Present value of cash flow
annual cash inflow	1-8	1,22,175	4.968	6,06.965
initial Investment				(4,50,000)

Net Present Value 1,56,965