Question

"Paul Restaurant is considering the purchase of a $9,300 soufflé maker. The soufflé maker has an economic life of five years and will be fully depreciated by the straight-line method. The machine will produce 1,400 soufflés per year, with each costing $1.97 to make and priced at $4.95. The discount rate is 14 percent and the tax rate is 21 percent. Should the company make the purchase? "

Answer 1

The decision should be made based on NPV

Annual depreciation =9300 / 5 = 1,860

Revenue = 1,400 * 4.95 = 6,930

Costs = 1,400 * 1.97 = 2,758

Operating cash flow from year 1 to year 5 = (Revenue - costs - depreciation)(1 - tax) + depreciation

Operating cash flow from year 1 to year 5 = (6,930 - 2,758 - 1,860)(1 - 0.21) + 1,860

Operating cash flow from year 1 to year 5 = 1,826.48 + 1,860

Operating cash flow from year 1 to year 5 = 3,686.48

NPV= Present value of cash inflows - present value of cash outflows

NPV= Annuity * [1 - 1 / (1 + r)^n] / r - Initial investment

NPV= 3,686.48 * [1 - 1 / (1 + 0.14)^5] / 0.14 - 9300

NPV= 3,686.48 * [1 - 0.519369] / 0.14 - 9300

NPV= 3,686.48 * 3.433081 - 9300

NPV= $3,355.98