Question

The plant has accumulated savings of $80,000 to acquire a new machine for the Manufacture Department....

The plant has accumulated savings of $80,000 to acquire a new machine for the Manufacture Department. The new machine costs $80,000. The Straight line depreciation method is used buy this plant in all its equipments. The income tax rate is 0.35. The new equipment will save $35,000 each year and its economic life is 5 years. The salvage value is $10,000. Does the acquisition of this new machine satisfy the 8% minimum rate? Compute the present worth after tax cash flow.

a. -$18,693

b. -$80,000

c.$66,550

d. $37,204

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Answer #1

Correct Answer:

D

Working note:

SL depreciation for the machine per year = (80000-10000)/5 = $14000

Savings after tax per year = (35000-14000)*(1-T)

Savings after tax per year = (35000-14000)*(1-35%)

Savings after tax per year = 13650

So,

Cash flow after tax per year = 13650 + 14000 = $27650

Now,

PW of the cash flows after tax = -80000 + 27650*(1-1/1.08^5)/.08 + 10000/1.08^5

PW of the cash flows after tax = $37204.26 or $37204

So, investment should take place as it brings positive net present worth.

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