Question

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ottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase...

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.)

Solutions

Expert Solution

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

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