Question

Caspian Sea Drinks is considering the purchase of a new water filtration system produced by Rube Goldberg Machines. This new equipment, the RGM-7000, will allow Caspian Sea Drinks to expand production. It will cost $15.00 million fully installed and will be fully depreciated over a 20 year life, then removed for no cost. The RGM-7000 will result in additional revenues of $3.48 million per year and increased operating costs of $563,233.00 per year. Caspian Sea Drinks' marginal tax rate is 34.00%. If Caspian Sea Drinks uses a 12.00% discount rate, then the net present value of the RGM-7000 is _____. (rounded to 2 decimals)

Answer 1

Solution

Formula for NPV

Where:

t =each period

T= holding period

r= Discount rate

C0= Initial investment

Ct= Cash flow in each period

Now here C0 = Initial investment= 15000000

Let us consider depreciation as straight-line depreciation over 20 years therefore yearly depreciation= 1/20= 5% = 750000

Now to find cashflow each year

Cash flow= Revenue- Operating cost-tax

Tax= (Revenue- Operating cost- depreciation)*tax rate

For example for first year

Tax= (3480000-563233-750000)*.34= 736700.78

Therefore Cash flow=Revenue-operating cost- (Revenue- Operating cost- depreciation)*tax rate

Cashflow for first year= 3480000-563233-736700.78= 2180066.2

Now for finding NPV we need to find PV of each cashflow

PV of cashflow for first year= 2180066.2/(1+.12)^1= 1946487.70

Similarly we will find out sum of PV of all years as given in table below

Sum of PV = 16283881.73

NPV=16283881.73- 15000000

=1283881.73

Calculation

Excel Formula used

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