Question

Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $6,000 and sell its old washer for $2,000. The new washer will last for 6 years and save $1,500 a year in expenses. The opportunity cost of capital is 16%, and the firm’s tax rate is 21%.

a. If the firm uses straight-line depreciation over a 6-year life, what are the cash flows of the project in years 0 to 6? The new washer will have zero salvage value after 6 years, and the old washer is fully depreciated. (Negative amount should be indicated by a minus sign.)

b. What is project NPV? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

c. What is NPV if the firm investment is entitled to immediate 100% bonus depreciation? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

a). Year 0 cash flow = after-tax selling price of old washer - purchase price of new washer

= 2,000*(1-21%) - 6,000 = -4,420

Depreciation p.a. = purchase price/6 = 6,000/6 = 1,000

Cash flow p.a. from Year 1 to Year 6 = savings*(1-Tax rate) + (depreciation*Tax rate)

= 1,500*(1-21%) + (1,000*21%) = 1,395

b). NPV = Present Value (PV) of all discounted cash flows

= -4,420 + 1,395*(1-(1+16%)^-6)/16% = 720.21

c). If 100% bonus depreciation is charged at Year 0 then the entire purchase price of 6,000 is depreciated at Year 0.

Year 0 cash flow = initial investment + (100% bonus depreciation*Tax rate)

= -4,420 + (6,000*21%) = -3,160

Cash flow p.a. from Year 1 to Year 6 = after-tax savings = 1,500*(1-21%) = 1,185

NPV = -3,160 + 1,185*(1-(1+16%)^-6)/16% = 1,206.41