Question

A Bakery is considering the purchase of a new $18,600 donut making machine. The new machine would permit the company to reduce the amount of part-time help needed, to a cost saving of $3,800 per year. In addition, the new machine would allow the company to produce a new type of donut, which would replace one existing type, resulting in the sale of 1,000 donuts with an additional $1.2 in revenue per donut. The new machine would have a 6-year life and will depreciated straight line. The salvage value at the end of year 6 is $9,125. The cost of capital is 12 percent.

1.Compute EBIT for each year. What is the EBIT in years 1 through 6? Tax rate is 40%.

2.What is the after-tax salvage value?

3.What is the cash flow is year 0?

4.What are the cash flows in years 1-5?

3800

3100

4240

5.Compute the NPV and IRR.

Answer 1

1.Compute EBIT for each year. What is the EBIT in years 1 through 6? Tax rate is 40%.

Increase in sales Revenue 1000*1.2	1200
cost saving	3800
Less Deprecitation 18600/6	3100
EBIT For Each Year	1900

2.What is the after-tax salvage value?

9125*(1-.40) =$5475

3.What is the cash flow is year 0?

$-18,600

4.What are the cash flows in years 1-5?

Increase in sales Revenue 1000*1.2	1200
cost saving	3800
Less Deprecitation 18600/6	3100
EBIT For Each Year	1900
Tax 40%	760
Profit Before tax	1140
Add depreciation	3100
Cash Flow	4240

5.Compute the NPV and IRR.

N	Cash Flow	PV factor	PV
0	-18600	1	-18600.00
1	4240	0.892857	3785.71
2	4240	0.797194	3380.10
3	4240	0.71178	3017.95
4	4240	0.635518	2694.60
5	4240	0.567427	2405.89
6	9715	0.506631	4921.92
NPV			1606.17

N	Cash Flow
0	-18600
1	4240
2	4240
3	4240
4	4240
5	4240
6	9715
IRR RATE	14.67%