A machine costs $460,000, has a $36,000 salvage value, is expected to last eight years, and...

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In: Accounting

A machine costs $460,000, has a $36,000 salvage value, is expected to last eight years, and will generate an after-tax income of $100,000 per year after straight-line depreciation.

Assume the company requires a 10% rate of return on its investments. Compute the net present value of each potential investment. (PV of $1, FV of $1, PVA of $1, and FVA of $1) (Use appropriate factor(s) from the tables provided.)

A new operating system for an existing machine is expected to cost $650,000 and have a useful life of six years. The system yields an incremental after-tax income of $190,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $50,000.

A machine costs $460,000, has a $36,000 salvage value, is expected to last eight years, and will generate an after-tax income of $100,000 per year after straight-line depreciation.

Answer 1)

Calculation of Net Present value

Net Present value = Present value of annual cash inflow + Present value of salvage value - Initial cash outflow

= $ 1,263,025.40 + $ 28,223.50 - $ 650,000

= $ 641,248.90 or $ 641,249 (rounded off)

Therefore the Net Present value of the investment is $ 641,249

Working Note:

Calculation of Annual depreciation

Annual depreciation = (Original cost – salvage value)/ number of years of useful life of the asset

= ($ 650,000 - $ 50,000)/6 years

= $ 100,000

Calculation of Annual Cash Inflow:

Annual cash inflow = Annual after tax income + Annual depreciation

= $ 190,000 + $ 100,000

= $ 290,000

Calculation of present value of Annual Cash Inflow:

Present value of annual cash inflow = Annual cash inflow X Present value annuity factory at 10% for 6 years

= $ 290,000 X 4.35526

= $ 1,263,025.40

Calculation of present value of Salvage value:

Present value of salvage value = Salvage value X Present value factor at 10% at the end of 6th year

= $ 50,000 X 0.56447

= $ 28,223.50

Answer 2)

Calculation of Net Present value

Net Present value = Present value of annual cash inflow + Present value of salvage value - Initial cash outflow

= $ 816,244.29 + $ 16,794.36 - $ 460,000

= $ 373,038.65 or $ 373,039 (rounded off)

Therefore the Net Present value of the investment is $ 373,039

Working Note:

Calculation of Annual depreciation

Annual depreciation = (Original cost – salvage value)/ number of years of useful life of the asset

= ($ 460,000 - $ 36,000)/8 years

= $ 53,000

Calculation of Annual Cash Inflow:

Annual cash inflow = Annual after tax income + Annual depreciation

= $ 100,000 + $ 53,000

= $ 153,000

Calculation of present value of Annual Cash Inflow:

Present value of annual cash inflow = Annual cash inflow X Present value annuity factory at 10% for 8 years

= $ 153,000 X 5.33493

= $ 816,244.29

Calculation of present value of Salvage value:

Present value of salvage value = Salvage value X Present value factor at 10% at the end of 8th year

= $ 36,000 X 0.46651

= $ 16,794.36

ekkarill92 answered 2 years ago

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Present Value

Annual cash flow

Residual value

Net present value

An asset costs $10,000 and has a depreciable life of 10 years and a salvage value of $3,000. Determine the book (asset) value at the end of the 9th year using each of the following methods of depreciation (a) double-declining-balance method (b) textbook-declining-balance method (Matheson formula), and (c) sum-of-years’ digits method.