Fairfax Pizza is considering buying a new oven. The new oven would be purchased today for 16,800 dollars. It would be depreciated straight-line to 1,200 dollars over 2 years. In 2 years, the oven would be sold for an after-tax cash flow of 2,000 dollars. Without the new oven, costs are expected to be 12,000 dollars in 1 year and 16,800 in 2 years. With the new oven, costs are expected to be 800 dollars in 1 year and 12,000 in 2 years. If the tax rate is 50 percent and the cost of capital is 6.42 percent, what is the net present value of the new oven project?
Depreciation = Historical cos - salvage value ) / useful life = ( 16800 - 1200 ) / 2 = 7800
Cash savings in year 1 = 12000 - 800 = 11200
cash saving in year 2 = 16800 -12000 = 4800
| Particulars | Year1 | Year 2 |
| Savings ( A) | 11200 | 4800 |
| Depreciation (B) | 7800 | 7800 |
| Cash flow before tax ( C = A-B) | 19000 | 12600 |
| Tax ( D = C *50%) | 9500 | 6300 |
| Cash flow after tax ( E = C - D) | 9500 | 6300 |
Net Present value = present value of cash inflows a-present value of cash outflows
= 9500 / 1.0642 + 6300 / 1.0642^ 2 + 2000 / 1.0642^2 - 16800
= 8926.89 + 5562.81 + 1765.97 - 16800
= 16255.67 - 16800
= - $544.33
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