Question

Fairfax Pizza is considering buying a new oven. The new oven would be purchased today for 14,000 dollars. It would be depreciated straight-line to 1,600 dollars over 2 years. In 2 years, the oven would be sold for an after-tax cash flow of 2,300 dollars. Without the new oven, costs are expected to be 14,000 dollars in 1 year and 17,900 in 2 years. With the new oven, costs are expected to be 3,800 dollars in 1 year and 14,300 in 2 years. If the tax rate is 50 percent and the cost of capital is 11.49 percent, what is the net present value of the new oven project?

Answer 1

Net Present Value = Present value of cash inflows - Present value of cash outflows
	Year 0	Year 1	Year 2
Purchase cost	(14,000.00)
Savings in cost		10,200.00	3,600.00
Depreciation		6,200.00	6,200.00
Increase in income before tax		4,000.00	(2,600.00)
Less: Tax		2,000.00	(1,300.00)
Net Income		2,000.00	(1,300.00)
Add: Depreciation		6,200.00	6,200.00
Operating Cash flow		8,200.00	4,900.00
Sale Proceeds			2,300.00
Total cash flow	(14,000.00)	14,400.00	13,400.00
Present value factor	1.000000	0.896941	0.804504
Present Value	(14,000.00)	12,915.96	10,780.35
Net Present value	9,696.31