Question

Caspian Sea Drinks is considering the purchase of a new water filtration system produced by Rube Goldberg Machines. This new equipment, the RGM-7000, will allow Caspian Sea Drinks to expand production. It will cost $12.00 million fully installed and will be fully depreciated over a 20 year life, then removed for no cost. The RGM-7000 will result in additional revenues of $3.21 million per year and increased operating costs of $581,786.00 per year. Caspian Sea Drinks' marginal tax rate is 26.00%. If Caspian Sea Drinks uses a 8.00% discount rate, then the net present value of the RGM-7000 is _____.

Answer 1

The incremental cash flows for produced by the RGM-7000

Annual Operating Cash Flow (OCF) = [(Annual revenues – Operating costs) x (1 – Tax Rate)] + [Depreciation x Tax Rate]

= [($3,210,000 - $581,786) x (1 – 0.26)] + [($12,000,000 / 20 Years) x 0.26]

= [$2,628,214 x 0.74] + [$600,000 x 0.26]

= $1,944,878.36 + $156,000

= $2,100,878.36

Net Present Value (NPV) of the RGM-7000

Years	Annual Cash Flow ($)	Present Value factor at 8.00%	Present Value of Cash Flow ($)
1	21,00,878.36	0.925925926	19,45,257.74
2	21,00,878.36	0.857338820	18,01,164.57
3	21,00,878.36	0.793832241	16,67,744.98
4	21,00,878.36	0.735029853	15,44,208.31
5	21,00,878.36	0.680583197	14,29,822.51
6	21,00,878.36	0.630169627	13,23,909.73
7	21,00,878.36	0.583490395	12,25,842.34
8	21,00,878.36	0.540268885	11,35,039.21
9	21,00,878.36	0.500248967	10,50,962.23
10	21,00,878.36	0.463193488	9,73,113.18
11	21,00,878.36	0.428882859	9,01,030.72
12	21,00,878.36	0.397113759	8,34,287.70
13	21,00,878.36	0.367697925	7,72,488.61
14	21,00,878.36	0.340461041	7,15,267.23
15	21,00,878.36	0.315241705	6,62,284.48
16	21,00,878.36	0.291890468	6,13,226.37
17	21,00,878.36	0.270268951	5,67,802.19
18	21,00,878.36	0.250249029	5,25,742.77
19	21,00,878.36	0.231712064	4,86,798.86
20	21,00,878.36	0.214548207	4,50,739.69
TOTAL			20,626,733.42

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $20,626,733.42 - $12,000,000

= $8,626,733.42

“Hence, the Net Present Value (NPV) of the RGM-7000 will be $8,626,733.42”

NOTE    

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.