Question

Norwest is planning on purchasing a welding machine. The expected cost of this machine is $60,000, and it is expected to have a useful life of 7 years with an estimated salvage value of $4,000. The machine is expected to produce cash savings of $20,000 per year in reduced labor costs and the cash operating costs to run this machine are estimated to be $6,000 per year. Assuming Norwest is in the 34% tax bracket and has a minimum desired rate of return of 14% on this investment.
Determine the payback period, the accounting rate of return, and the net present value for this investment. (Indicate answers to 2 decimal places)

Answer 1

Solution)

Tax rate	34%	Discount Rate	14%
Time Peroid	7
Cash Outlay	60000
Salvage Value	4000
Depreciation Each Peroid	8000
Investment Outlays at Time Zero:				0	1	2	3	4	5	6	7
Equipment				$ 60,000
Operating Cash Flows over the Project's Life:
Sales revenue					$   20,000	$ 20,000	$ 20,000	$ 20,000	$ 20,000	$ 20,000	$ 20,000
Fixed operating costs					$     6,000	$    6,000	$    6,000	$    6,000	$    6,000	$    6,000	$    6,000
Depreciation (equipment)					$     8,000	$    8,000	$    8,000	$    8,000	$    8,000	$    8,000	$    8,000
Oper. income before taxes (EBIT)					$     6,000	$    6,000	$    6,000	$    6,000	$    6,000	$    6,000	$    6,000
Taxes on operating income (34%)					$     2,040	$    2,040	$    2,040	$    2,040	$    2,040	$    2,040	$    2,040
Net Operating Profit After Taxes (NOPAT)					$     3,960	$    3,960	$    3,960	$    3,960	$    3,960	$    3,960	$    3,960
Add back depreciation					$     8,000	$    8,000	$    8,000	$    8,000	$    8,000	$    8,000	$    8,000
Operating cash flow					$   11,960	$ 11,960	$ 11,960	$ 11,960	$ 11,960	$ 11,960	$ 11,960
Terminal Year Cash Flows:
Net salvage value											0
Net Cash Flow (Time line of cash flows)				($60,000)	$11,960	$11,960	$11,960	$11,960	$11,960	$11,960	$11,960
Net Present Value (at 14%)			-$8,712
Payback (See calculation below)			5.02
Data for Payback    Years				0	1	2	3	4	5	6	7
	Net cash flow			-60,000	11,960	11,960	11,960	11,960	11,960	11,960	11,960
	Cumulative CF			-60,000	-48,040	-36,080	-24,120	-12,160	-200	11,760	23,720
	Part of year required for payback:				1.00	1.00	1.00	1.00	1.00	0.02	0.00