Question

Rocky Mountain Lumber, Inc., is considering purchasing a new wood saw that costs $65,000. The saw will generate revenues of $100,000 per year for five years. The cost of materials and labor needed to generate these revenues will total $60,000 per year, and other cash expenses will be $10,000 per year. The machine is expected to sell for $4,000 at the end of its five-year life and will be depreciated on a straight-line basis over five years to zero. Rocky Mountain’s tax rate is 34 percent, and its opportunity cost of capital is 16.70 percent. What is the project's NPV? Should the company purchase the saw? (Round answer to the nearest whole dollar, e.g. 5,275. Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).)

Answer 1

given,

initial investment = $65,000.

discounting rate (r) = 16.7%

depriciation per year = 65000/5 = $13,000

Total inflows per year = $100,000

Total outflows per year = cost of labor and material + other cash expense = 60000 + 10000 = $70,000

Net inflows per year = 100000 - 70000 = $30,000

profit before tax per year = 30000 -depreciation = 30000 - 13000 = $17,000

Tax per year = 17000 *34% = 5780.

net inflow after tax per year = 30000 - 5780 = $24,220.

post tax income on sale of asset at yr 5 = 4000 * (1 - 0.34) = $2,640

NPV = -initial investment + present value of net inflows after tax of all years + present value of post tax income on sale of asset.

therefore ,

Therefore,

NPV = $14,245