Question

IQ Electronics, which assembles printed circuit boards, is considering the purchase of a new IC chip placement machine. It has a first cost of $300,000 and is expected to save them $125,000 per year in labour and operating costs compared with the system they have now. The life of the system is expected to be four years. The salvage value of the machine is expected to be $100,000. IQ's nominal tax rate is 40%, and the equipment CCA rate is Class 8 declining balance with only half of the CCA eligible in year 1.

What is the net present worth, given an MARR of 15%? Should IQ proceed with this purchase?

If the initial investment of $300,000 must be financed by a bank, at an effective annual interest rate of 12%/year over 4 years, is the project still worth pursuing? Explain in one sentence what has happened.

Answer 1

Year	0	1	2	3	4	NPV
Initial Cash Outlay	-300,000
Salvage value after tax					80,736
Capital (outlay)/inflow	-300,000	-	-	-	80,736
Annual Saving		125,000	125,000	125,000	125,000
Less: Depreciation		60,000	96,000	57,600	34,560
Profit before tax		65,000	29,000	67,400	90,440
Tax at 40%		26,000	11,600	26,960	36,176
Net Income		39,000	17,400	40,440	54,264
Add: Depreciation		60,000	96,000	57,600	34,560
Operating cash Flow		99,000	113,400	98,040	88,824
Free Cash Flow	-300,000	99,000	113,400	98,040	169,560
Disc fact=1/(1+15%)^n	1.00000	0.86957	0.75614	0.65752	0.57175
Disc. Cash Flow	-300,000	86,087	85,747	64,463	96,946	33,243
Since NPW>0, so project should be accepted
Calculation of depreciation
Year		1	2	3	4
Rate of Depn		20%	40%	40%	40%
Beg. Balance		300,000	240,000	144,000	86,400
Depreciation		60,000	96,000	57,600	34,560
Ending Balance		240,000	144,000	86,400	51,840
Calculation of Salvage value after tax
Salvage Value		100,000
Less: Book Value		51,840
Gain on sale		48,160
Tax on gain at 40%		19,264
Salvage Value after tax		80,736	=100000-19264
Year	0	1	2	3	4	NPV
Repayment of bank loan					-300,000
Salvage value after tax					80,736
Capital (outlay)/inflow	-	-	-	-	-219,264
Annual Saving		125,000	125,000	125,000	125,000
Less: Interest @12%		36,000	36,000	36,000	36,000
Less: Depreciation		60,000	96,000	57,600	34,560
Profit before tax		29,000	-7,000	31,400	54,440
Tax at 40%		11,600	-2,800	12,560	21,776
Net Income		17,400	-4,200	18,840	32,664
Add: Depreciation		60,000	96,000	57,600	34,560
Operating cash Flow		77,400	91,800	76,440	67,224
Free Cash Flow	-	77,400	91,800	76,440	-152,040
Disc fact=1/(1+15%)^n	1.00000	0.86957	0.75614	0.65752	0.57175
Disc. Cash Flow	-	67,304	69,414	50,261	-86,929	100,050
Since NPW>0, so project should be accepted