Question

Fairfax Pizza is considering buying a new oven. The new oven would be purchased today for 15,000 dollars. It would be depreciated straight-line to 2,200 dollars over 2 years. In 2 years, the oven would be sold for an after-tax cash flow of 3,500 dollars. Without the new oven, costs are expected to be 11,400 dollars in 1 year and 18,500 in 2 years. With the new oven, costs are expected to be 2,600 dollars in 1 year and 15,300 in 2 years. If the tax rate is 50 percent and the cost of capital is 10.51 percent, what is the net present value of the new oven project?

Answer 1

Annual Operating cashflows
			YEar1	YEar2
Annual savings in cost			8800	3200
Less: Depreciation			6400	6400
Before tax Income			2400	-3200
Tax @ 50%			1200	1600
After tax income			1200	-1600
Add: Depreciation			6400	6400
Annual Operating cashflows			7600	4800
NPV:
			YEar0	YEar1	YEar2
Initial investment			-15000
Annual Operating CF				7600	4800
After tax salvage					3500
Net Cashflows			-15000	7600	8300
PVF at 10.51%			1	0.904895	0.818836
Present Value of CF			-15000	6877.206	6796.337
NPV			-1326