Question

A project has an initial cost of $47,325, expected net cash inflows of $9,000 per year for 11 years, and a cost of capital of 8%. What is the project's NPV? (Hint: Begin by constructing a time line.) Do not round your intermediate calculations. Round your answer to the nearest cent.

Net Salvage Value

Allen Air Lines must liquidate some equipment that is being replaced. The equipment originally cost $19 million, of which 85% has been depreciated. The used equipment can be sold today for $4.75 million, and its tax rate is 40%. What is the equipment's after-tax net salvage value? Write out your answer completely. For example, 2 million should be entered as 2,000,000.

The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer's base price is $950,000, and it would cost another $20,500 to install it. The machine falls into the MACRS 3-year class (the applicable MACRS depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%), and it would be sold after 3 years for $691,000. The machine would require an increase in net working capital (inventory) of $14,500. The sprayer would not change revenues, but it is expected to save the firm $462,000 per year in before-tax operating costs, mainly labor. Campbell's marginal tax rate is 35%. What is the Year 0 net cash flow? $ What are the net operating cash flows in Years 1, 2, and 3? Do not round intermediate calculations. Round your answers to the nearest dollar. Year 1 $ Year 2 $ Year 3 $ What is the additional Year 3 cash flow (i.e, the after-tax salvage and the return of working capital)? Do not round intermediate calculations. Round your answer to the nearest dollar. $ If the project's cost of capital is 14 %, what is the NPV of the project? Do not round intermediate calculations. Round your answer to the nearest dollar. $ Should the machine be purchased? -Select-YesNoItem 7

Answer 1

Answer 1:

NPV = $16,925.68

Working:

Initial cost = $47,325

Expected net cash inflows per year for 11 years = $9,000

Cost of capital = 8%

NPV = Annual cash flow * PV of $1 annuity for 11 years at 8% rate - Initial cost

= 9000 * (1 -1 / (1 + 8%) ¹¹) / 8% - 47325

= $16925.68

Answer 2:

Equipment's after-tax net salvage value = $3,990,000

Working:

Original cost = $19 million = $19,000,000

85% depreciated.

Hence:

Current Book value = 19000000 * (1 - 85%) = $2,850,000

Used equipment can be sold today for = $4.75 million = $4,750,000

Tax on Gain = (4750000 - 2850000) * 40% = $760,000

Equipment's after-tax net salvage value = 4750000 - 760000 = $3,990,000

Answer 3 (a)

Installed cost of machine = Base price + cost of installation = 950000 + 20500 = $970,500

Year 0 net cash flow = - (Installed cost of machine + Increase in net working capital) = - (970500 + 14500) = - $985,000

Year 0 net cash flow = - $985,000

Answer 3(b):

Working:

Answer 3(c):

Answer 3(d):

NPV of the project = $291,569

Answer 3(e):

Yes,

The machine should be purchased. Its NPV is positive.

Year 1 Year 2 Year 3 $413,513.68 $451,285.54 $350,605.87

Year Before tax Savings in operating cost After tax savings in operating cost $462,000.00 $300,300.00 2 $462,000.00 $300,300.00 3 $462,000.00 $300,300.00 Depreciation rate Depreciation Depreciation tax shield 33.33% 44.45% 14.81% ($323,467.65) ($431,387.25) ($143,731.05) $113,213.68 $150,985.54 $50,305.87 Net operating cash flows $413,513.68 $451,285.54 $350,605.87

Additional Year 3 cash flow: Book Value of machine Sale value of machine Tax on Gain After Tax Sale value of machine Recovery of working capital $71,914.05 $691,000.00 ($216,680.08) $474,319.92 $14,500.00 Additional Year 3 cash flow: $488,819.92

Year Initial cost Increase in working capital 0 ($970,500.00) ($14,500.00) Before tax Savings in operating cost After tax savings in operating cost $462,000 $300,300 $462,000 $300,300 $462,000 $300,300 Depreciation rate Depreciation Depreciation tax shield 33.33% 44.45% 14.81% ($323,467.65) ($431,387.25) ($143,731.05) $113,214 $150,986 $50,306 Net operating cash flows $413,513.68 $451,285.54 $350,605.87 $647,032.35 $215,645.10 Additional Year 3 cash flow: Book Value of machine Sale value of machine Tax on Gain After Tax Sale value of machine Recovery of working capital $71,914.05 $691,000 ($216,680.08) $474,319.92 $14,500 Additional Year 3 cash flow: $488,819.92 ($985,000.00) Cash flow PV Factor (1/(1+14%) «Year) PV of cash flows NPV $413,513.68 0.8771930 $362,731.30 $451,285.54 0.7694675 $347,249.57 $839,425.79 0.6749715 $566,588.49 ($985,000.00) $291,569.36