Question

Omaha Plating Corporation is considering purchasing a machine for $1,500,000. The machine will generate a constant after-tax income of $100,000 per year for 15 years. The firm will use straight-line (SL) depreciation for the new machine over 10 years with no residual value. Its estimated weighted-average cost of capital (WACC) for evaluating capital expenditure proposals is 10%. Note: the PV $1 factor for 10 years, 10% is 0.386; the PV annuity factor for 10%, 10 years is 6.145; and, the PV annuity factor for 10%, 5 years is 3.791. Required: 1. Using a discount rate of 10%, what is the estimated net present value (NPV) of the proposed investment (rounded to the nearest thousand)? 2. What would be your decision (accept o reject the project)? Why? Explain

Answer 1

(1)- Net Present Value (NPV) of the Project

The Net Present Value (NPV) of the Project = Present Value of Annual Cash Inflows – Initial Investments

Annual Cash Inflow = After-tax Net Income + Depreciation Expenses

= $100,000 + [$15,00,000 / 10 Years]

= $100,000 + 150,000

= $250,000 per year

The Net Present Value (NPV) of the Project = Present Value of Annual Cash Inflows – Initial Investments

= $250,000[PVIAF 10%, 10 Years] – 15,00,000

= [$250,000 x 6.145] – 15,00,000

= $15,36,250 – 15,00,000

= $36,250

“The estimated net present value (NPV) of the proposed investment = $36,250”

(2)-Decision

The Project should be accepted, since Net Present Value (NPV) of the Project is Positive $36,250