Question

# For this question start fresh, do not carry over data from earlier questions. You are analyzing...

For this question start fresh, do not carry over data from earlier questions. You are analyzing the prospects of installing cost saving machinery. You have the following information: The machine costs \$92,000. Depreciation is calculated straight line (equal amounts) over 4 years. Every year the machine increases cash flows by an amount 36,000. (Taxes, Opportunity Cost etc. have all been accounted for in this number. There is no Net Working Capital.) After 3 years (when the machine has only been depreciated for 3 years and therefore the book value is not zero) the machine is sold for \$30,000. This, therefore, is a 3 year project. The rate of discount is 9% The tax rate is 40%. (Hint: Here you have to consider the income due to the salvage sale of the machinery and the taxes on this sale.) What is the NPV of installing the machinery?

Annual Depreciation = Cost of Investment / No. of Life years

= \$92,000 / 4 = \$23,000

Book Value after 3 Years = Cost of machine - Accumulated Depreciation

= \$92,000 - (\$23,000 x 3) = \$23,000

After-Tax Salvage Value = Salvage Value - [Tax Rate x (Salvage Value - Book Value)]

= \$30,000 - [0.40 x (\$30,000 - \$23,000)] = \$30,000 - \$2,800 = \$27,200

NPV = PV of Cash Inflows - PV of Cash Outflows

= [\$36,000/1.09] + [\$36,000/1.092] + [(\$36,000 + \$27,200)/1.093] - \$92,000

= \$33,027.52 + \$30,300.48 + \$48,802 - \$92,000 = \$20,130

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