Question

a) T&T Workshop is considering a four-year project to improve its production efficiency. Buying a new machine press for $560,000 is estimated to result in $210,000 in annual pre-tax cost savings. The press will be depreciated straight-line to zero over its four-year tax life. Assume the tax rate is 25 percent. Compute the operating cash flow and net present value for this new machine press. If the required return is 12 percent, should T&T Workshop buy in the new machine press?

Answer 1

Total Cost of new machine is $560,000

Based on straight line depreciation method for 4 years will be $140,000

Depreciation =560000/4

= $140000

Calculation of Post Tax Income

Particulars	Amount
Annual Pretax cost savings	$210,000
Less : Depreciation	($140,000)
Pre tax income	$70,000
Tax Expense (25%) on Pretax income	*($17500)
Post Tax Income	$52500

*Calculation of income tax expense = 70000*25% = $17500

Calculation of Operating Cash flow

Particulars	Amount
Post Tax Income	$52500
Add: Depreciation	$140,000
Operating Cash Flow	$192,500

Required Return is 12%

Calculation of Net Present Value

Cash Outflow = $560,000

Cash Inflow Every year for next 4 years = $192,500

Present Value of all 4 years = Cash Inflow year 1 / (1+R) + Cash Inflow year 2 / (1+R)^2 + Cash Inflow year 3 / (1+R)^3 + Cash Inflow year 4 / (1+R)^4

=192500/(1+0.12) + 192500/(1+0.12)^2 + 192500/(1+0.12)^3 + 192500/(1+0.12)^4

=171875 + 153460 + 137018 + 122337

=584690

Net Present Value = Present value Cash Inflows - Cash outflow

Net Present Value = 584690 - 560000

Net Present Value = $24690

T&T Workshop should buy the new machine press as it has positive net present value of $24690