Question

1. A new operating system for an existing machine is expected to cost $650,000 and have a useful life of six years. The system yields an incremental after-tax income of $175,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $23,800.
2. A machine costs $540,000, has a $35,900 salvage value, is expected to last eight years, and will generate an after-tax income of $70,000 per year after straight-line depreciation.

Assume the company requires a 12% rate of return on its investments. Compute the net present value of each potential investment. (PV of $1, FV of $1, PVA of $1, and FVA of $1) (Use appropriate factor(s) from the tables provided.)

	Cash Flow Select Chart Amount x PV Factor = Present Value Annual cash flow = Residual value = Net present value

	Cash Flow Select Chart Amount x PV Factor = Present Value Annual cash flow = Residual value = Net present value

Answer 1

Cost of operating system = $650,000

Salvage value = $23,800

Useful life = 6 years

Annual depreciation expense = (Cost of operating system- Salvage value)/Useful life

= (650,000-23,800)/6

= $104,367

Annual after tax income = $175,000

Annual cash inflow = Annual depreciation expense + Annual after tax income

= 104,367+175,000

= $279,367

Cash Flow	Select Chart	Amount	x	PV Factor	=	Present Value
Annual cash flow	Present value annuity	279,367	x	4.11141	=	1,148,592
Residual value	Present value	23,800	x	0.50663	=	12,058
	Present value of cash inflow					1,160,650
	Initial investment					-650,000
	Net present value					510,650

Part 2:

Cost of machine = $540,000

Salvage value = $35,900

Useful life = 8 years

Annual depreciation expense = (Cost of operating system- Salvage value)/Useful life

= (540,000-35,900)/8

= $63,013

Annual after tax income = $70,000

Annual cash inflow = Annual depreciation expense + Annual after tax income

= 63,013+70,000

= $133,013

Cash Flow	Select Chart	Amount	x	PV Factor	=	Present Value
Annual cash flow	Present value annuity	133,013	x	4.96764	=	660,761
Residual value	Present value	35,900	x	0.40388	=	14,499
	Present value of cash inflow					675,260
	Initial investment					-540,000
	Net present value					135,260