Question

Snowy Mountain Timber Ltd is considering purchasing a new wood saw that costs $50,000. The saw will generate revenues of $100,000 per year for five years. The cost of materials and labour needed to generate these revenues will total $60,000 per year, and other cash expenses will be $10,000 per year. The machine is expected to sell for $4,000 at the end of its five-year life and will be depreciated on a straight-line basis over five years to zero. Snowy Mountain’s tax rate is 34 percent, and its opportunity cost of capital is 13.30 percent.

The project's NPV is?

The project should be accepted/rejected

Answer 1

The project's NPV is $32,420.01.

The project should be accepted.

Step-1:Calculation of annual operating cash flow
	Revenue		$       1,00,000
	Less:
	Cost of materials & Labor	$       60,000
	Other cash expense	$       10,000
	Depreciation expense	$       10,000	$           80,000
	Profit before tax		$           20,000
	Less: Tax expense		$             6,800
	Net income		$           13,200
	Add:Depreciation		$           10,000
	Operating cash flow		$           23,200
Working:
Depreciation expense	=	(Cost - Salvage value)/Useful life
	=	(50000-0)/5
	=	$       10,000
Step-2:Calculation of present value of annual cash inflow
Present value of operating cash inflow	=	Annual operating cash flow	*	Present value of annuity of 1	=	$     23,200	*	3.491638	=	$ 81,005.99
Present value of salvage value	=	After tax salvage value	*	Present value of 1	=	$ 2,640.00	*	0.535612	=	$   1,414.02
Present value of cash inflow										$ 82,420.01
Working:
	# 1	Present value of annuity of 1	=	(1-(1+i)^-n)/i		Where,
			=	(1-(1+0.1330)^-5)/0.1330		i	13.30%
			=	3.4916377		n	5
	# 2	After tax salvage value	=	Before tax salvage value	*	(1-Tax rate)
			=	$ 4,000.00	*	(1-0.34)
			=	$ 2,640.00
	# 3	Present value of 1	=	(1+i)^-n
			=	(1+0.1330)^-5
			=	0.5356122
Step-3:Calculation of net present value
	Present value of cash inflow		$     82,420.01
	Less cost of project		$     50,000.00
	Net Present value (NPV)		$     32,420.01