Question

A company is considering a 6-year project that requires an initial outlay of $23,000. The project engineer has estimated that the operating cash flows will be $4,000 in year 1, $6,000 in year 2, $7,000 in year 3, $7,000 in year 4, $7,000 in year 5, and $8,000 in year 6. At the end of the project, the equipment will be fully depreciated, classified as 5-year property under MACRS. The project engineer believes the equipment can be sold for $5,000 at the end of the project. If the tax rate is 26% and the required rate of return is 18%, what is the net present value (NPV) of this project? (Answer to the nearest dollar.)

Answer 1

Calculation of NPV of the project
Year	0	1	2	3	4	5	6	NPV
Initial Outlay on Equipment	-$23,000.00
Operating cash flow		$4,000.00	$6,000.00	$7,000.00	$7,000.00	$7,000.00	$8,000.00
Tax @ 26% on operating cash flow		-$1,040.00	-$1,560.00	-$1,820.00	-$1,820.00	-$1,820.00	-$2,080.00
Depreciation tax shield		$1,196.00	$1,913.60	$1,148.16	$688.90	$688.90	$344.45
Equipment salvage value							$5,000.00
Tax @ 26% on Salvage value							-$1,300.00
Net Cash flow	-$23,000.00	$4,156.00	$6,353.60	$6,328.16	$5,868.90	$5,868.90	$9,964.45
Discount Factor @ 18%	1	0.84746	0.71818	0.60863	0.51579	0.43711	0.37043
Present Values	-$23,000.00	$3,522.03	$4,563.06	$3,851.51	$3,027.11	$2,565.35	$3,691.15	-$1,779.79
NPV of the project =	-$1,780
Calculation of Depreciation tax shield
Year	Equipment Cost	Depreciation rate	Depreciation	Tax shield @ 26%
1	23000	20%	$4,600.00	$1,196.00
2	23000	32%	$7,360.00	$1,913.60
3	23000	19.20%	$4,416.00	$1,148.16
4	23000	11.52%	$2,649.60	$688.90
5	23000	11.52%	$2,649.60	$688.90
6	23000	5.76%	$1,324.80	$344.45