Question

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?

Answer 1

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