Question

Johnny’s Lunches is considering purchasing a new, energy-efficient grill. The grill will cost $43,000 and will be depreciated straight-line over 3 years. It will be sold for scrap metal after 5 years for $10,750. The grill will have no effect on revenues but will save Johnny’s $21,500 in energy expenses. The tax rate is 30%. Required:

a. What are the operating cash flows in each year?

Year 1:

Year 2:

Year 3:

b. What are the total cash flows in each year?

Time 0:

Time 1:

Time 2:

Time 3:

c. Assuming the discount rate is 12%, calculate the net present value (NPV) of the cash flow stream.

Should the grill be purchased?

Answer 1

Solution :

a. The operating cash flows in each year are as follows :

Year 1: $ 5,016.67

Year 2: $ 5,016.67

Year 3: $ 5,016.67

b. The total cash flows in each year are as follows :

Time 0: - $ 43,000

Time 1: $ 19,350

Time 2: $ 19,350

Time 3: $ 19,350

c. The net present value (NPV) of the cash flow stream is = $ 25,849.64

Since the NPV is positive, the grill should be purchased.

Note :

1. Annual Depreciation = Cost of the asset / Depreciable life of the asset = $ 43,000 / 3 = $ 14,333.33

2. After tax salvage value = Salvage value * ( 1 - Tax rate ) = $ 10,750 * ( 1 - 0.30 ) = $ 10,750 * 0.70

= $ 7,525

Please find the attached screenshot of the excel sheet containing the detailed calculation for the solution.