Question

XYZ corp. is considering investing in a new machine. The new machine cost will $ 8,000 installed. Depreciation expense on the new machine will be $ 1,200 per year for the next five years. At the end of the fifth year XYZ expects to sell the machine for $3000. XYZ will also sell its old machine today that has a book value of $4000 for $4000. The old machine has depreciation expense of $800 per year and zero salvage value. Additionally, XYZ Corp expects that the new machine will increase its EBIT by $3000 in each of the next five years. Assuming that XYZ’s marginal tax rate is 21% and the projects cost of capital is 12%, What is the projects NPV? Round your final answer to two decimals.

Answer 1

Incremental Initital investment = new machine cost - sale of old machine = $8,000 - $4,000 = $4,000

Incremental Depreciation = New Machine Depreciation - Old Machine Depreciaiton = $1200 - $900 = $400

Book value of new machine at the end of year 5 = $8,000 - (5 *$1,200) = $2,000

Tax on sale of new machine at the end of year 5 = (Sale value - book value) * tax rate

= ($3,000 - $2,000) * 21%

= $210

After tax sale value of new machine = Sale - Tax on sale

= $3,000 - $210

= $2,790

Incremental salvage value = After tax salvage value of new machine - after tax salvage value of old machine

= $2,790 - 0

= $2,790

Calculation of NPV of the Project
Particulars	0	1	2	3	4	5
Initial Investment
Incremental investment (A)	-4000
Operating Cash Flows
Increase in EBIT (B)		3000	3000	3000	3000	3000
Incremental Depreciation (C )		400	400	400	400	400
Profit Before Tax (D = B-C)		2600	2600	2600	2600	2600
Tax @21% (E = D*21%)		546	546	546	546	546
Profit After Tax (F = D-E)		2054	2054	2054	2054	2054
Add back Depreciation (G = C)		400	400	400	400	400
Net Operating Cash flows (H = F+G)		2454	2454	2454	2454	2454
Terminal Value
Incremental Salvage Value (I)						2790
Total Cash Flows (J = A+H+I)	-4000	2454	2454	2454	2454	5244
Discount Factor @12% (K) 1/(1+12%)^n n=0,1,2,3,4,5	1	0.892857143	0.797193878	0.711780248	0.635518078	0.567426856
Discounted Cash flows (L = J*K)	-4000	2191.071429	1956.313776	1746.708728	1559.561364	2975.586431
NPV of the Project	6429.241728

Therefore, Projects NPV is $6,429.24