Question

Daily Enterprises is purchasing a $10.31 million machine. It will cost $66,186.00 to transport and install the machine. The machine has a depreciable life of five years using the straight-line depreciation and will have no salvage value. The machine will generate incremental revenues of $4.60 million per year along with incremental costs of $1.35 million per year. Daily’s marginal tax rate is 37.00%.

The cost of capital for the firm is 14.00%.

(answer in dollars..so convert millions to dollars)

The project will run for 5 years. What is the NPV of the project at the current cost of capital?

Answer 1

NPV of the project = Present value of cash flows + Present value of Depreciation tax shield - Initial Investment

Net cash flows post tax each year = (Incremental Revenue - Incremental Cost)*(1-Tax Rate). = ($4.60 - $1.35)*(1-0.37). = $2.0475 each year

Present value of net cash flows = $2.0475/1.14 + $2.0475/1.14^2............+$2.0475/1.14^5

= $70,29,233

Initial Investment = $66,186 + $10310000 = $10442372

Depreciation each year = $10442372/5 = $2088474

Depreciation tax shield = $2088474*.37 = $772736 each year

Present value of depreciation tax shield = $772736/1.14 + $772736/1.14^2.....+$772736/1.14^5 = $26,52,865

Hence NPV = $7029233 + $2652865 - $10442372 = -$7,60,274