Question

The COO of AppleLike Inc. is considering an investment in a new machine for iPadLike production. The machine costs $420,000. The COO expects to make iPadLikes on this machine for 6 years, and then he will no longer use the machine. Revenues are expected to be $100,000 each year for this machine. The machine is also expected to decrease production costs of the company by $35,000 per year. There is no net change in working capital due to the new machine. The market value of the machine in 6 years is expected to be $15,000. The company will depreciate the machine using straight-line depreciation, the corporate tax rate is 20%, and the required rate of return demanded by the company on any capital expenditure is 18%. Should the company buy the machine? Provide the NPV to justify your choice.

Answer 1

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Increase in revenue (A)		100,000	100,000	100,000	100,000	100,000	100,000
Decrease in costs (B)		35,000	35,000	35,000	35,000	35,000	35,000
Net Increase (C=A+B)		135,000	135,000	135,000	135,000	135,000	135,000
Tax on Net Increase @ 20% (D)		27,000	27,000	27,000	27,000	27,000	27,000
After Tax Net Increase (E=C-D)		108,000	108,000	108,000	108,000	108,000	108,000
Tax savings on Depreciation ((420000-15000)/6)*20% (F)		13,500	13,500	13,500	13,500	13,500	13,500
After Tax Salvage Value (15000*(1-0.2)) (G)							12,000
Purchase of machine (H)	-       420,000
Net Cashflows (I=E+F+G+H)	-       420,000	121,500	121,500	121,500	121,500	121,500	133,500
Discounting factor @ 18% (J)	1	0.85	0.72	0.61	0.52	0.44	0.37
		(1/1.18)	(0.85/1.18)	(0.72/1.18)	(0.61/1.18)	(0.52/1.18)	(0.44/1.18)
Present Value of cashflows (K=I*J)	-       420,000	102,966	87,259	73,949	62,668	53,109	49,453
NPV (Sum of K)	9,404

Since NPV of the project is positive, the company should buy the machine