Question

For this question start fresh, do not carry over data from earlier questions. You are analyzing the prospects of installing cost saving machinery. You have the following information:

• The machine costs $84,000. Depreciation is calculated straight line (equal amounts) over 4 years.

• Every year the machine increases cash flows by an amount 40,000. (Taxes, Opportunity Cost etc. have all been accounted for in this number. There is no Net Working Capital.)

• After 3 years (when the machine has only been depreciated for 3 years and therefore the book value is not zero) the machine is sold for $30,000. This, therefore, is a 3-year project.

• The rate of discount is 8%.

• The tax rate is 36%.

• (Hint: Here you have to consider the income due to the salvage sale of the machinery and the taxes on this sale.)

What is the NPV of installing the machinery?

Answer 1

Time line		0	1	2	3
Cost of new machine		-84000
=Initial Investment outlay		-84000
						100.00%
Depreciation	Cost of equipment/no. of years		-21000	-21000	-21000	21000	=Salvage Value
=after tax operating cash flow			40000	40000	40000
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				19200
+Tax shield on salvage book value	=Salvage value * tax rate				7560
=Terminal year after tax cash flows					26760
Total Cash flow for the period		-84000	40000	40000	66760
Discount factor=	(1+discount rate)^corresponding period	1	1.08	1.1664	1.259712
Discounted CF=	Cashflow/discount factor	-84000	37037.03704	34293.55281	52996.24041
NPV=	Sum of discounted CF=	40326.83