Question

3

A. Oxygen Optimization is considering buying a new purification system. The new system would be purchased today for 16,000 dollars. It would be depreciated straight-line to 1,200 dollars over 2 years. In 2 years, the system would be sold and the after-tax cash flow from capital spending in year 2 would be 2,100 dollars. The system is expected to reduce costs by 4,700 dollars in year 1 and by 13,000 dollars in year 2. If the tax rate is 50 percent and the cost of capital is 9.2 percent, what is the net present value of the new purification system project

B.What is the NPV of project A? The project would require an initial investment in equipment of 88,000 dollars and would last for either 3 years or 4 years (the date when the project ends will not be known until it happens and that will be when the equipment stops working in either 3 years from today or 4 years from today). Annual operating cash flows of 29,040 dollars per year are expected each year until the project ends in either 3 years or 4 years. In 1 year, the project is expected to have an after-tax terminal value of 57,840 dollars. The cost of capital for this project is 5.76 percent.

C Litchfield Design is evaluating a 3-year project that would involve buying a new piece of equipment for 310,000 dollars today. The equipment would be depreciated straight-line to 40,000 dollars over 2 years. In 3 years, the equipment would be sold for an after-tax cash flow of 48,000 dollars. In each of the 3 years of the project, relevant revenues are expected to be 252,000 dollars and relevant costs are expected to be 97,000 dollars. The tax rate is 50 percent and the cost of capital for the project is 8.71 percent. What is the NPV of the project?

Answer 1

A

	T0	T1	T2
Purchase cost	-16,000
Depreciation tax saving	-	3,700	3,700
Cost reduction after tax	-	2,350	6,500
Sale of equipment_after tax			2,100
Net flows	-16,000	6,050	12,300
PV factor	1	1	1
Net present value	-16,000	5,540	10,315	-145

B

3 years
Investment	-88000
Annual operating cashflow	29040
PV factor @ 5.76%	2.685
Present value of annual CF	77970
Net present value	-10030
4 years
Investment	-88000
Annual operating cashflow	29040
PV factor @ 5.76%	3.484
Present value of annual CF	101182
Net present value	13182

C

	T0	T1	T2	T3
Investment	-3,10,000
Depreciation_tax save @ 50%		67,500	67,500
Revenue		2,52,000	2,52,000	2,52,000
Costs		-97,000	-97,000	-97,000
Tax on Revenue-cost		-77,500	-77,500	-77,500
Sale of equipment_after tax				48,000
Net cash inflows	-3,10,000	1,45,000	1,45,000	1,25,500
PV factor @ 8.71%	1	0.919879	0.846177	0.77838
Discounted NPV	-3,10,000	1,33,382	1,22,696	97,687	43,765