Question

Quip Corporation wants to purchase a new machine for $500,000. Management predicts that the machine will produce sales of $210,000 each year for the next 6 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $80,000 per year. The firm uses straight-line depreciation with an assumed residual (salvage) value of $35,000 and no gain on sale of the equipment at the end of it's life. Quip's combined income tax rate, t, is 35%.

Management requires a minimum after-tax rate of return of 9% on all investments. What is the estimated net present value (NPV) of the proposed investment (rounded to the nearest hundred)? (The PV annuity factor for 9%, 6 years, is 4.486 and for 5 years it is 3.89. The present value $1 factor for 9%, 6 years, is 0.596.) Assume that after-tax cash inflows occur at year-end.

		$112,000.
		$21,600.
		$79,800.
		$48,800.

Answer 1

Solution:

Computation of annual cash inflows
Particulars	Amount
Sales revenues	$210,000.00
Expenses	$80,000.00
Depreciation	$77,500.00
Income before taxes	$52,500.00
Income tax expense (35%)	$18,375.00
Net Income	$34,125.00
Add: Depreciation	$77,500.00
Annual cash inflows	$111,625.00

Computation of NPV
Particulars	Amount	Period	PV Factor	Present Value
Cash Outflows:
Cost of Equipment	$500,000.00	0	1	$500,000
Present Value of Cash Outflows (A)				$500,000
Cash Inflows:
Annual cash inflows	$111,625.00	1-6	4.486	$500,750
Residual value	$35,000.00	6	0.596	$20,860
Present Value of Cash Inflows (B)				$521,610
Net Present Value (B-A)				$21,610

Hence 2nd option is correct.