Question

Universal Electronics is considering the purchase of manufacturing equipment with a 10-year midpoint in its asset depreciation range (ADR). Carefully refer to Table 12–11 to determine in what depreciation category the asset falls. (Hint: It is not 10 years.) The asset will cost $120,000, and it will produce earnings before depreciation and taxes of $30,000 per year for three years, and then $20,000 a year for seven more years. The firm has a tax rate of 25 percent. Assume the cost of capital is 12 percent. In doing your analysis, if you have years in which there is no depreciation, merely enter a zero for depreciation. Use Table 12–12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

a. Calculate the net present value.

Answer 1

1. Since in the present question life of the asset is not mentioned. We assume it to be 10 years, hence depreciation per year would be $ 12000.

We have to calculate net cash infow

= Earnings before Depn and tax - Dep - Tax + Depreciation

Hence Net Cash Inflow for 3 Years

= 30000 -12000 - 25 % * 18000 + 12000 = 25500 * PVAF of 3 years (2.41) = $ 61455

Net Cah Inflow for 7 Years

=20000- 12000 - 25 % * 8000 + 12000 = 18000 * PVAF of 7 years ( 3.24) = $ 58320

Sum of Net Cash Inflows = 61455 + 58320 = $ 119775

NPV = $ 120000 = $ 119775 = - 225 $