Question

Paul Restaurant is considering the purchase of a $10,200 soufflé maker. The soufflé maker has an economic life of 6 years and will be fully depreciated by the straight-line method. The machine will produce 1,400 soufflés per year, with each costing $2.40 to make and priced at $4.85. The discount rate is 13 percent and the tax rate is 21 percent.

  

What is the NPV of the project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Should the company make the purchase? Yes or No?

Answer 1

Annual depreciation=(Cost-Residual value)/Useful Life

=(10200/6)=$1700/year

Hence annual operating cash flow=(Revenue-Costs)(1-tax rate)+Tax savings on Annual depreciation

=[(4.85*1400)-(2.4*1400)](1-0.21)+(0.21*1700)

=(6790-3360)(1-0.21)+(0.21*1700)

=$3066.7

Present value of annuity=Annuity[1-(1+interest rate)^-time period]/rate

=$3066.7[1-(1.13)^-6]/0.13

=$3066.7*3.997549789

=$12259.29

NPV=Present value of inflows-Present value of outflows

=$12259.29-$10200

=$2059.29(Approx).

Hence since NPV is positive;company should make the purchase.