Question

The latest manufacturing equipment is purchased at a cost of $800,000. As a result, annual cash revenues are expected to increase by $345,000; annual cash expenses are expected to increase by $162,000; straight-line depreciation is used; the asset has a seven-year life; the salvage value is $100,000. Assume the company is in the new 21% corporate tax bracket.

Determine the NPV assuming a minimum required rate of return of 8%? Please show work.

Answer 1

Annual depreciation = ( Cost price - Salvage value) / Useful life

= (800,000-100,000)/7

= $100,000

Income Statement

Cash revenue	345,000
Cash expense	-162,000
Cash Income	183,000
Depreciation	-100,000
Profit before tax	83,000
Income tax expense ( 83,000 x 21%)	-17,430
Profit after tax	65,570
Depreciation	100,000
Annual Cash Inflows	165,570

Present value of cash inflows = Annual cash inflows x Present value annuity factor (8%,7) + Salvage value x Present value Factor (8%,7)

= 165,570 x 5.20637 + 100,000 x 0.58349

= 862,018.681+ 58,349

= 920,368

Net present value = Present value of cash inflows - Cost of equipment

= 920,368-800,000

= $120,368

Note: Exact answer may slightly differ due to rounding off and factor value considered