Question

5. ABC Telecom plans to purchase a new machine that will produce mobile phones. The new machine will require an initial investment of $450,000 and has an economic life of five years and will be fully depreciated by the straight-line method. The machine will produce 20.000 mobile phones per year with each costing $120,00 to make. Each will be sold at $130,00. Assume LAR Telecom uses a discount rate of 22 percent and has a tax rate of 40 percent. What is the NPV of the project and should LAR Telecom make the purchase? If not, please explain why.

Answer 1

Tax rate		40%
Calculation of annual depreciation
Depreciation		Year-1	Year-2	Year-3	Year-4	Year-5	Total
Cost		$            450,000	$           450,000	$            450,000	$            450,000	$           450,000
Dep Rate		20.00%	20.00%	20.00%	20.00%	20.00%
Depreciation		$              90,000	$             90,000	$              90,000	$              90,000	$             90,000	$            450,000
Calculation of after-tax salvage value
Cost of machine			$           450,000
Depreciation			$           450,000
WDV			$                      -
Sale price			$                      -
Profit/(Loss)			$                      -
Tax			$                      -
Sale price after-tax			$                      -
Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4	Year-5
No of units		20,000	20,000	20,000	20,000	20,000
Selling price		$                    130	$                   130	$                    130	$                    130	$                   130
Operating ost		$                    120	$                   120	$                    120	$                    120	$                   120
Sale		$        2,600,000	$       2,600,000	$        2,600,000	$        2,600,000	$       2,600,000
Less: Operating Cost		$        2,400,000	$       2,400,000	$        2,400,000	$        2,400,000	$       2,400,000
Contribution		$            200,000	$           200,000	$            200,000	$            200,000	$           200,000
Less: Depreciation		$              90,000	$             90,000	$              90,000	$              90,000	$             90,000
Profit before tax		$            110,000	$           110,000	$            110,000	$            110,000	$           110,000
Tax@40%		$              44,000	$             44,000	$              44,000	$              44,000	$             44,000
Profit After Tax		$              66,000	$             66,000	$              66,000	$              66,000	$             66,000
Add Depreciation		$              90,000	$             90,000	$              90,000	$              90,000	$             90,000
Cash Profit after-tax		$            156,000	$           156,000	$            156,000	$            156,000	$           156,000
Calculation of NPV
						22.00%
Year		Capital		Operating cash	Annual Cash flow	PV factor	Present values
0		$         (450,000)			$         (450,000)	1.0000	$         (450,000)
1				$            156,000	$            156,000	0.8197	$            127,869
2				$            156,000	$            156,000	0.6719	$            104,811
3				$            156,000	$            156,000	0.5507	$              85,910
4				$            156,000	$            156,000	0.4514	$              70,418
5		$                       -		$            156,000	$            156,000	0.3700	$              57,720
					Net Present Value		$              (3,272)
Since NPV is negative, it is not advisable to make a purchase.