Question

Chicago Manufacturing Co. is looking to purchase a new Forklift that costs $15,000. This new machine will replace their current fully depreciated Forklift that they think they can sell for $1,500. The new Forklift will allow the company to produce more flats which will result in new sales of $7,500 per year with increased costs of $1,500 per year. They expect to be able to sell the Forklift at the end of 10 years for $1,500 and will be straight-lined depreciated over the 10-year period to zero.

Chicago Manufacturing Co. has a marginal tax rate of 34% and its required rate of return is 15%.  What is the NPV of the project?

Answer 1

Computation of Initial Cashoutflow

S.No	Particulars	Amount
A	Current value of old forklift	$1,500
B	Tax @ 34% on A	$510.00
C	After tax Proceeds ( A-B)	$990.00
D	Cost of New forklift	$15,000
E	Net Cashoutflow( D-C)	$14,010.00

Since the old forklift is fully depreciated so tax will be applicable on initial outflow.

Hence Cashoutflow is $ 14010

Computation of Present Value of Cash inflows

S.No	Particulars	Amount
A	Sales	$7,500
B	Cost	$1,500
C	Depreciation	$1,500
D	Profit Before Tax( A-B-C)	$4,500
E	Tax @ 34% on D	$1,530.00
F'	Profit After Tax ( D-E)	$2,970.00
G	Annual Cash flow( F+C)	$4,470.00

Depreciation = Cost of Asset / Useful life

= $ 15000/10

= $ 1500.

Present value of Cashflows accruing from year 1 to Year 10= C* [ { 1-( 1+i) ^-n} /i]

Here C = Cash flow per period

I = Rate of interest

n = No.of years

Present Value of future Cashinflows= C* [ { 1-( 1+i) ^-n} /i]

= $ 4470[ { 1-( 1+0.15)^-10}/0.15]

= $ 4470[ { 1-(1.15)^-10}/0.15]

= $ 4470[ { 1-0.247185}/0.15]

= $ 4470[ {0.752815/0.15}]

= $ 4470( 5.018767)

= $ 22433.89

Computation of After tax Proceeds from the sale of new forklift

S.No	Particulars	Amount
A	Salvage Value	$1,500
B	Book value of forklift	0
C	Gain on Disposal( A-B)	$1,500
D	Tax @34% on C	$510.00
E	After Tax Proceeds ( C-D)	$990.00

Present Value of after tax proceeds = Future value / ( 1+i)^n

Here I = Rate of interest and n = No.of Years

PV of after tax salvage value = $ 990/ ( 1+0.15)^10

= $ 990/ ( 1.15)^10

= $ 990/ 4.04556

= $ 244.712

Computation of NPV

S.No	Particulars	Amount
A	PV of Cashinflow	$22,433.89
B	PV of after tax salvage value	$244.7127
C	Total cashinflows( A+B)	$22,678.60
D	Initial outtlay	$14,010.00
E	NPV ( C-D)	$8,668.60

Hence NPV of a project is $ 8668.60

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