In: Finance
ottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $6,600 and sell its old washer for $2,300. The new washer will last for 6 years and save $1,800 a year in expenses. The opportunity cost of capital is 19%, and the firm’s tax rate is 40%.
a. If the firm uses straight-line depreciation to an assumed salvage value of zero over a 6-year life, what is the annual operating cash flow of the project in years 0 to 6? The new washer will in fact have zero salvage value after 6 years, and the old washer is fully depreciated. (Negative amount should be indicated by a minus sign.)
b. What is project NPV? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)
c. What is NPV if the firm uses MACRS depreciation with a 5-year tax life? Use the MACRS depreciation schedule. (Do not round intermediate calculations. Round your answer to 2 decimal places.)
a] | ANNUAL OPERATING CASH FLOWS: | |||||||
Savings in expenses per year | $ 1,800.00 | |||||||
Less: Depreciation of new washer = 6600/6 = | $ 1,100.00 | |||||||
Incremental net operating income | $ 700.00 | |||||||
Tax at 40% | $ 280.00 | |||||||
Incremental NOPAT | $ 420.00 | |||||||
Add: Depreciation | $ 1,100.00 | |||||||
Annual operating cash flow | $ 1,520.00 | |||||||
b] | INITIAL INVESTMENT: | |||||||
Cost of the new car washer | $ 6,600.00 | |||||||
Less: After tax sale value of old car washer = 2300*(1-40%) = | $ 1,380.00 | |||||||
Initial investment | $ 5,220.00 | |||||||
NPV: | ||||||||
PV of incremental OCF at 19% = 1520*(1.19^6-1)/(0.19*1.19^6) = | $ 5,182.86 | |||||||
Less: Iniitial investment | $ 5,220.00 | |||||||
NPV | $ -37.14 | |||||||
c] | NPV WITH MACRS DEPRECIATION: | 0 | 1 | 2 | 3 | 4 | 5 | 6 |
Savings in expenses per year | $ 1,800.00 | $ 1,800.00 | $ 1,800.00 | $ 1,800.00 | $ 1,800.00 | $ 1,800.00 | ||
Less: Depreciation of new washer-MACRS | $ 1,320.00 | $ 2,112.00 | $ 1,267.20 | $ 760.32 | $ 760.32 | $ 380.16 | ||
Incremental net operating income | $ 480.00 | $ -312.00 | $ 532.80 | $ 1,039.68 | $ 1,039.68 | $ 1,419.84 | ||
Tax at 40% | $ 192.00 | $ -124.80 | $ 213.12 | $ 415.87 | $ 415.87 | $ 567.94 | ||
Incremental NOPAT | $ 288.00 | $ -187.20 | $ 319.68 | $ 623.81 | $ 623.81 | $ 851.90 | ||
Add: Depreciation | $ 1,320.00 | $ 2,112.00 | $ 1,267.20 | $ 760.32 | $ 760.32 | $ 380.16 | ||
Annual operating cash flow | $ 1,608 | $ 1,925 | $ 1,587 | $ 1,384 | $ 1,384 | $ 1,232 | ||
PVIF at 19% | 1 | 0.84034 | 0.70616 | 0.59342 | 0.49867 | 0.41905 | 0.35214 | |
PV at 19% | $ 1,351.26 | $ 1,359.23 | $ 941.68 | $ 690.22 | $ 580.02 | $ 433.86 | ||
Sum of PV of annual cash flows | $ 5,356.27 | |||||||
Less: Iniitial investment | $ 5,220.00 | |||||||
NPV | $ 136.27 |