Question

Co. is considering purchasing a piece of equipment costing $300,000. It has a useful life of 3 years and will be depreciated straight-line to zero, after which it will be scrapped for $20,000. This piece of equipment will save Teer Co. $125,000 per year in pretax operating costs during its useful life but requires an initial investment in NWC of $50,000. Teer Co. has a 20% tax rate and a required rate of return of 10%.

What is the annual Operating Cash Flow (OCF) of this piece of equipment in Years 1-3?

A.) 170k

B.) 149k

C.) 98k

D.) 120k

What is the Year 3 IATCF (Investment After-Tax Cash Flow)? Hint: You need to account for the after-tax salvage value and for net working capital.

A.) 142k

B.) 186k

C.) 171k

D.) 204k

What is the NPV of purchasing this piece of equipment?

A.)-$1991

B.)$2874

C.)$4096

D.) -$3984

Answer 1

Solution:
Calculation of NPV
Particulars	Years	Amount	PVF @ 10%	Present Value
Cash Outflows:
Purchase Amount	0	300,000	1	300,000.00
Net Working Capital	0	50,000	1	50,000.00
Present Value of Cash Outflows(A)		350,000		350,000.00
Cash Inflows:
Operating Cost Flow after Tax (125000-(1-0.20))	1-3	100,000	2.4869	248,690.00
Tax Saving on Depreciation (300000/3)*20%	1-3	20,000	2.4869	49,738.00
Scrapped Value (Net of Tax) ( 20000)(1-0.20)	3	16,000	0.7512	12,019.20
Net Working Capital	3	50,000	0.7512	37,560.00
Present Value of Cash Inflows (B)		186,000		348,007.20
NPV (B)-(A)				(1992.80)	(approx)
1. Option D is correct i.e. 120K
Operating cash flow after tax + tax saving on depreciation = 100000+20000= 1,20,000
2. Option B is correct i.e. 186K
Year 3 IATCF- Operating Cash Flow after Tax + Tax Saving on Depreciation + Scrapped Value + Net Working Capital
Year 3 IATCF- 100000+20000+16000+50000= 1,86,000
3. Option A is correct i.e. - $1991
NPV -$1991 as shown in the above table