Question

A company can buy a machine that is expected to have a three-year life and a $40,000 salvage value. The machine will cost $1,840,000 and is expected to produce a $210,000 after-tax net income to be received at the end of each year. If a table of present values of 1 at 12% shows values of 0.8929 for one year, 0.7972 for two years, and 0.7118 for three years, what is the net present value of the cash flows from the investment, discounted at 12%?

$134,011

$605,030

$645,732

$723,249

$1,974,011

Answer 1

Net present value = Present value of cash inflows - Initial Investment

Annual depreciation expense = (Cost of the machine - Salvage value) / Estimated useful life

= ($ 1,840,000 - $ 40,000) / 3 = $ 600000

Annual cash inflows = Annual after-tax net income + Annual depreciation expense

= $ 210,000 + $ 600,000 = $ 810,000

Present value of cash inflows at discount rate of 12%

= Annual cash inflows x PVA_{i=12%, n=3} + Salvage value x PV_{i=12%, n=3}

= $ 810,000 x ( 0.8929 + 0.7972 + 0.7118) + $ 40,000 x 0.7118

= $ 1,945,539 + $ 28,472

=$ 1,974,011

Net present value = $ 1,974,011 - $1,840,000 = $ 134,011