Question

Fairfax Pizza is considering buying a new oven. The new oven would be purchased today for 14,000 dollars. It would be depreciated straight-line to 1,400 dollars over 2 years. In 2 years, the oven would be sold for an after-tax cash flow of 2,600 dollars. Without the new oven, costs are expected to be 10,000 dollars in 1 year and 19,900 in 2 years. With the new oven, costs are expected to be 1,500 dollars in 1 year and 17,100 in 2 years. If the tax rate is 50 percent and the cost of capital is 9.75 percent, what is the net present value of the new oven project?

Answer 1

	Annual depreciation on new oven		6300
	(14000-1400)/2
	Annual depreciation tax shield =6300*50%	3150
	Post tax salvage value			2000
	2600-(2600-1400)*50%
	Year	0	1	2
	Initial investment	-14000
	Cost with oven		1500	17100
	Cost with out oven		10000	19900
i	saving in cost		8500	2800
ii	Post tax cost saving		4250	1400
iii	Depreciation tax shield =	3150	3150
iv=ii+iii	Operating cash flow		7400	4550
	Post tax salvage value			2000
	Net cash flow	-14000	7400	6550
	PVIF @ 9.75%	1	0.911162	0.830216
	present value	(14,000.00)	6,742.60	5,437.91	(1,819.49)
	NPV =	(1,819.49)
	Ans =	(1,819.49)