Question

Your corporation is considering replacing older equipment. The old machine is fully depreciated and cost $60,304.00 seven years ago. The old equipment currently has no market value. The new equipment cost $74,133.00 . The new equipment will be depreciated to zero using straight-line depreciation for the four-year life of the project. At the end of the project the equipment is expected to have a salvage value of $13,952.00 . The new equipment is expected to save the firm $15,285.00 annually by increasing efficiency and cost savings. The corporation has tax rate of 39.45% and a required return on capital of 8.55% .

a) What is the total initial cash outflow? (show as negative number)

b) What are the estimated annual operating cash flows?

c) What is the terminal cash flow?

d) What is the NPV for this project?

Answer 1

Answer to Part a:

Cost of New Equipment

Initial Cash Outflow = -Cost of New Equipment
Initial Cash Outflow = -$74,133.00

Answer to Part b:

Initial Investment = $74,133.00
Useful Life = 4 years

Annual Depreciation = Initial Investment / Useful Life
Annual Depreciation = $74,133.00 / 4
Annual Depreciation = $18,533.25

Annual Operating Cash Flow = Pretax Cost Saving * (1 - tax) + tax * Depreciation
Annual Operating Cash Flow = $15,285.00 * (1 - 0.3945) + 0.3945 * $18,533.25
Annual Operating Cash Flow = $15,285.00 * 0.6055 + 0.3945 * $18,533.25
Annual Operating Cash Flow = $16,566.43

Answer to Part c:

Salvage Value = $13,952.00

After-tax Salvage Value = Salvage Value * (1 - tax)
After-tax Salvage Value = $13,952.00 * (1 - 0.3945)
After-tax Salvage Value = $8,447.94

Terminal Cash Flow = After-tax Salvage Value
Terminal Cash Flow = $8,447.94

Answer to Part d:

Required return = 8.55%

NPV = -$74,133.00 + $16,566.43/1.0855 + $16,566.43/1.0855^2 + $16,566.43/1.0855^3 + $16,566.43/1.0855^4 + $8,447.94/1.0855^4
NPV = -$13,843.38