Question

Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $9,000 and sell its old washer for $2,200. The new washer will last for 6 years and save $2,700 a year in expenses. The opportunity cost of capital is 19%, and the firm’s tax rate is 40%.

a. If the firm uses straight-line depreciation to an assumed salvage value of zero over a 6-year life, what is the annual operating cash flow of the project in years 0 to 6? The new washer will in fact have zero salvage value after 6 years, and the old washer is fully depreciated. (Negative amount should be indicated by a minus sign.)

Annual operating cas flow in yr 0 ___?

Annual operatng cash flow in years 1-6_____?

b. What is project NPV? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)

  

c. What is NPV if the firm uses MACRS depreciation with a 5-year tax life? Use the MACRS depreciation schedule. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

a. Annual Operating Cash Flow in Year 0 = $0 (As the new asset operations has not yet started)

a1. Annual Operating Cash Flow in Year 1 - 6 = Savings in Expenses * (1 - tax) + tax Shield on Depreciation

Annual Operating Cash Flow in Year 1 - 6 = 2700 * (1 - 0.40) + (0.40 * $9000/6)

Annual Operating Cash Flow in Year 1 - 6 = $2220

b. Computation of NPV

Net Present Value = New Washer Cost + Sale of Old Washer * (1 - Tax) + Operating cash Flow * PVAF ( 19%, 6)

Net Present Value = -9000 + 2200 * (1 - 0.40) + 2220 * 3.409777

Net Present Value = -9000 + 2200 * (1 - 0.40) + 2220 * 3.409777

Net Present Value = -110.29

c. NPV if MACRS Depreciation is used

NPV = $126.17