Question

Oxygen Optimization is considering buying a new purification system. The new system would be purchased today for 20,200 dollars. It would be depreciated straight-line to 2,000 dollars over 2 years. In 2 years, the system would be sold and the after-tax cash flow from capital spending in year 2 would be 2,600 dollars. The system is expected to reduce costs by 7,400 dollars in year 1 and by 14,100 dollars in year 2. If the tax rate is 50 percent and the cost of capital is 7.41 percent, what is the net present value of the new purification system project?

Answer 1

Annual Operating cashflows
			YEar1	YEar2
Annual savings in cost			7400	14100
Less: Depreciation			9100	9100
Before tax Income			-1700	5000
Tax @ 50%			850	2500
After tax income			-850	2500
Add: Depreciation			9100	9100
Annual Operating cashflows			8250	11600
NPV:
			YEar0	YEar1	YEar2
Initial investment			-20200
Annual Operating CF				8250	11600
After tax salvage					2600
Net Cashflows			-20200	8250	14200
PVF at 7.41%			1	0.931012	0.866783
Present Value of CF			-20200	7680.849	12308.32
NPV			-211