Question

Snowy Mountain Timber Ltd is considering purchasing a new wood saw that costs $55,000. The saw will generate revenues of $100,000 per year for five years. The cost of materials and labour needed to generate these revenues will total $60,000 per year, and other cash expenses will be $10,000 per year. The machine is expected to sell for $3,000 at the end of its five-year life and will be depreciated on a straight-line basis over five years to zero. Snowy Mountain’s tax rate is 34 percent, and its opportunity cost of capital is 12.70 percent. The project's NPV is $______, The project should be accepted/rejected.

Answer 1

Annual depreciation = 55,000 / 5 = 11,000

Operating cash flow for year 1 to year 5 = (Revenue - cost - expenses - depreciation)(1 - tax) + depreciation

Operating cash flow for year 1 to year 5 = (100,000 - 60,000 - 10,000 - 11,000)(1 - 0.34) + 11,000

Operating cash flow for year 1 to year 5 = 23,540

Year 5 non operating cash flow = Market value - tax(market value - book value)

Year 5 non operating cash flow = 3,000 - 0.34(3,000 - 0)

Year 5 non operating cash flow = 3,000 - 1,020

Year 5 non operating cash flow = 1,980

NPV = Present value of cash inflows - present value of cash outflows

NPV = -55,000 + 23,540 / (1 + 0.127)¹ + 23,540 / (1 + 0.127)² + 23,540 / (1 + 0.127)³ + 23,540 / (1 + 0.127)⁴ + 23,540 / (1 + 0.127)⁵ + 1,980 / (1 + 0.127)⁵

NPV = $29,594.33

Project should be accepted as it has a positive NPV