Question

XYZ corp. is considering investing in a new machine. The new machine cost will $10,000 installed. Depreciation expense will be $1000 per year for the next five years. At the end of the fifth year XYZ expects to sell the machine for $6000. XYZ will also sell its old equipment today that has a book value of $3000 for $3000. In five years, the old machine will be fully depreciated and have a salvage value of zero. Additionally, XYZ Corp expects that the new machine will increase its EBIT by $2000 in each of the next five years. Assuming that XYZ’s tax rate is 21% and the new machines WACC is 15%, what is the projects NPV. Round your final answer to two decimals.

Answer 1

Cost of New Machine = $10,000

.

Depreciation expense = $1,000 per year for next 5 years

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Salvage value at the end of 5th year = $6,000

Book Value of the machine = $10,000 – ($1,000*5)

= 10,000 – 5,000

= $5,000

.

Profit on sale of new machine at the end of 5^th year = 6,000 – 5,000 = $1,000

Tax on profit on sale of New Machine = 1,000*21% = $210

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Therefore , After tax salvage value of the new machine at the end of 5^th year = Sales Value of new machine (i.e. salvage value)– Tax on profit on sale of New Machine

= 6,000 – 210

= $5,790

.

.

Initial Investment of the Project = Cost of New Machine – Sales Realization from sale of Old Machine

= $10,000 - $3,000

= $7,000

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Calculation of NPV:

	{II}	{1}	{2}	{3} = {1}*{2}	{4}	{5} = {4}*21%	{6}	{7} = {II} + {3} + {5} +{6}		{8}	{9} = {7}*{8}
Year	Initial Investment	Increase in EBIT	Tax @ 21%	After tax EBIT	Depreciation	Dpn Tax Shield	After Tax Salvage Value	Net Cash Flow	DF Working	Discounting Factor @ 15%	Present value
0	(7,000)	-	-	-	-	-	-	(7,000)	1	1	(7,000.00)
1	-	2,000	420	1,580	1,000	210	-	1,790	1/1.15^1	0.869565217	1,556.52
2	-	2,000	420	1,580	1,000	210	-	1,790	1/1.15^2	0.756143667	1,353.50
3	-	2,000	420	1,580	1,000	210	-	1,790	1/1.15^3	0.657516232	1,176.95
4	-	2,000	420	1,580	1,000	210	-	1,790	1/1.15^4	0.571753246	1,023.44
5	-	2,000	420	1,580	1,000	210	5,790	7,580	1/1.15^5	0.497176735	3,768.60
										NPV:	1,879.01

.

.

Therefore, NPV of the project is $1879.01.The project is viable , since NPV is Positive.