Question

A company is considering the purchase of a large stamping machine that will cost $155,000, plus $5,900 transportation and $11,100 installation charges. It is estimated that, at the end of five years, the market value of the machine will be $44,000. The IRS has established that this machine will fall under a three-year MACRS class life category. The justifications for the machine include $32,000 savings per year in labor and $42,000 savings per year in reduced materials. The before-tax MARR is 20% per year, and the effective income tax rate is 40%. What is the after-tax equivalent annual worth of this investment over the five year period which ends with the sale of the machine?

Answer 1

Step 1 Calculation of Depreciation
	Total cost of machine = 155000+5900+11100
			=172000
		Year	Rate of Depreciation as per MACRS	Deprectaion
		1	33.33	57327.6
		2	44.45	76454
		3	14.81	25473.2
		4	7.41	12745.2
		Total		172000
Step 2: Calculation of Annual Cash Flow
	Particulars	Year 1	Year 2	Year 3	Year 4	Year 5
	Saving in Labour Cost	32000	32000	32000	32000	32000
	Saving in Material Cost	42000	42000	42000	42000	42000
	Total Saving	74000	74000	74000	74000	74000
	Less Depreciation	57327.6	76454	25473.2	12745.2	0
	Saving After Depreciation	16672.4	-2454	48526.8	61254.8	74000
	Less: Tax @40%	6668.96	-981.6	19410.72	24501.92	29600
	Earning After Tax	10003.44	-1472.4	29116.08	36752.88	44400
	Add: Depreciation	57327.6	76454	25473.2	12745.2	0
	Net Annual Cash In flow	67331.04	74981.6	54589.28	49498.08	44400
Step 3: Calculation of Terminal Cash Flow
	Cash Flow from Sale of Machine	44000
	Less: Tax on Gain @40%	17600
	Net Cash Flow	26400
Step: 4 Calculation of Discount Rate
	Discount Rate =Pre Tax Discount Rate (1-Tax)
	=20 %(1-40%)
	=12%
Step: 4	Calculation of Net Present Value
	Year	Cash Flows	PV Factor @ 12%	Present Value in Option A
	0	-172000	1	-172000
	1	67331.04	0.89285714	60117
	2	74981.6	0.79719388	59774.87
	3	54589.28	0.71178025	38855.57
	4	49498.08	0.63551808	31456.92
	5	44400	0.56742686	25193.75
	5	26400	0.56742686	14980.07
	Net Present Value			58378.19
Step 5: After tax Equivalent annual worth
	Equivalent Annual Worth = NPV / Present Value Annuity Factor(Discount rate,years)
		=58378.19 / 3.604
		=16198.17