Question

Equipment is purchased at a cost of $80,000. As a result, annual cash revenues are expected to increase by $45,000; annual cash expenses are expected to increase by $12,000; straight-line depreciation is used; the asset has a seven-year life; the salvage value is $10,000. Assume the company is in a 34% tax bracket.

Determine the NPV assuming a minimum required rate of return of 8%?

Please kindly explain in detail how you arrived at your answers especially how you calculate the PV. Thank you

Answer 1

Equipment is purchased at a cost of $80,000. As a result, annual cash revenues are expected to increase by $45,000; annual cash expenses are expected to increase by $12,000; straight-line depreciation is used; the asset has a seven-year life; the salvage value is $10,000

Annual depreciation = (Cost of asset - Salvage value)/Useful life

= (80,000 - 10,000)/7

= $10,000

Cash revenues	45,000
Cash expenses	- 12,000
Depreciation	- 10,000
Profit before tax	23,000
Tax	- 7,820
Profit after tax	15,180
Depreciation	10,000
Annual Cash inflow after tax	$25,180

Present value of cash inflows = Annual cash inflow after tax x Present value annuity factor (8%,7) + Salvage value x Present value factor (8%, 7)

= 25,180 x 5.20637 + 10,000 x 0.58349

= $131,096.40 + 5,834.9

= $136,931 (Rounded to near Dollar)

NPV = Present value of cash inflows - Present value of cash outflows

= 136,931 - 80,000

= $56,931

Exact answers may slightly differ due to rounding off.