Question

Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $6,900 and sell its old washer for $2,100. The new washer will last for 6 years and save $1,900 a year in expenses. The opportunity cost of capital is 18%, and the firm’s tax rate is 21%.

a. If the firm uses straight-line depreciation over a 6-year life, what are the cash flows of the project in years 0 to 6? The new washer will have zero salvage value after 6 years, and the old washer is fully depreciated. (Negative amounts should be indicated by a minus sign.)

b. What is project NPV? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

c. What is NPV if the firm investment is entitled to immediate 100% bonus depreciation? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Time line		0	1	2	3	4	5	6
Proceeds from sale of existing asset	=selling price* ( 1 -tax rate)	1659
Tax shield on existing asset book value	=Book value * tax rate	0
Cost of new machine		-6900
=Initial Investment outlay		-5241
									100.00%
Savings			1900	1900	1900	1900	1900	1900
-Depreciation	Cost of equipment/no. of years		-1150	-1150	-1150	-1150	-1150	-1150	0	=Salvage Value
=Pretax cash flows			750	750	750	750	750	750
-taxes	=(Pretax cash flows)*(1-tax)		592.5	592.5	592.5	592.5	592.5	592.5
+Depreciation			1150	1150	1150	1150	1150	1150
=after tax operating cash flow			1742.50	1742.50	1742.5	1742.5	1742.5	1742.5
+Tax shield on salvage book value	=Salvage value * tax rate							0
=Terminal year after tax cash flows								0
a. Total Cash flow for the period		-5241	1742.50	1742.50	1742.50	1742.5	1742.5	1742.5
Discount factor=	(1+discount rate)^corresponding period	1	1.18	1.3924	1.643032	1.93878	2.2877578	2.6995542
Discounted CF=	Cashflow/discount factor	-5241	1476.694915	1251.436369	1060.539296	898.762	761.66281	645.47696
b. NPV=	Sum of discounted CF=	853.57

Time line		0	1	2	3	4	5	6
Proceeds from sale of existing asset	=selling price* ( 1 -tax rate)	1659
Tax shield on existing asset book value	=Book value * tax rate	0
Cost of new machine		-6900
=Initial Investment outlay		-5241
									100.00%
Savings			1900	1900	1900	1900	1900	1900
-Depreciation			-6900	0	0	0	0	0	0	=Salvage Value
=Pretax cash flows			-5000	1900	1900	1900	1900	1900
-taxes	=(Pretax cash flows)*(1-tax)		-3950	1501	1501	1501	1501	1501
+Depreciation			6900	0	0	0	0	0
=after tax operating cash flow			2950.00	1501.00	1501	1501	1501	1501
+Tax shield on salvage book value	=Salvage value * tax rate							0
=Terminal year after tax cash flows								0
Total Cash flow for the period		-5241	2950.00	1501.00	1501.00	1501	1501	1501
Discount factor=	(1+discount rate)^corresponding period	1	1.18	1.3924	1.643032	1.93878	2.2877578	2.6995542
Discounted CF=	Cashflow/discount factor	-5241	2500	1077.994829	913.5549399	774.199	656.10093	556.01774
c. NPV=	Sum of discounted CF=	1236.87