Question

Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $1,800 and sell its old washer for $600.

The new washer will last for 6 years and save $500 a year in expenses. The opportunity cost of capital is 19%, and the firm's tax rate is 21%.

A) If the firm uses straight-line depreciation over a 6-year life, what are the cash flows of the project in years 0 to 6? The new washer will have zero salvage value after 6 years, and the old washer is fully depreciated. (Negative amounts should be indicated by a minus sign.)

B) What is the project NPV? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

C) What is NPV if the firm investment is entitled to an immediate 100% bonus depreciation? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Cash flow from sale of old machine

Sale Value	600
Book value	0
Capital gain	600
tax @ 21%	126
Cash Flow	474

A. Initial Investment (Year 0)
Cost of Machine	1,800
Proceeds from sale of old machine	-474
Total Outlow (A)	1,326

Depreciaiton = 1800 / 6 = 300

Particulars	Cash Flow
Operating Profit	500
Less : Depreciation	300
Earning Before Tax	200
Less : Tax	42
Earning After Tax	158
Add Back : Depreciation	300
Cash flow After Tax (Year 1-6)	458

PV of this Cash Flow
CFAT	458
PVAF 19%, 6 years	3.409
PV of CFAT (B)	1,561

Calculation Of NPV
Initial Outflow (A)	-1,326
PV of Annual Cash Flow (B)	1,561
PV of Terminal Cash Flow "C"	0
Net Present Value	235

c) If we avail 100% bonus depreciation in year 1 there will be a loss in year 1

which will lead to a tax credit of 273 which can be carried forwad to set off tax in future as shown in table

Year	Earning Before Tax	Tax Amount	Cumulative Tax amount	Effect on Cash Flow
1	-1300	-273	-273	0
2	500	105	-168	0
3	500	105	-63	0
4	500	105	42	42

Particulars	1	2	3	4	5	6
Operating Profit	500	500	500	500	500	500
Less : Depreciation	1800	0	0	0	0	0
Earning Before Tax	-1300	500	500	500	500	500
Less : Tax	0	0	0	42	105	105
Earning After Tax	-1300	500	500	458	395	395
Add Back : Depreciation	1800	0	0	0	0	0
Cash flow After Tax (Year 1-6)	500	500	500	458	395	395
PV Factor @19%	0.84	0.71	0.59	0.50	0.42	0.35
PV	420.17	353.08	296.71	228.39	165.52	139.10
Sum of PV	1,602.97

Calculation Of NPV
Initial Outflow (A)	-1,326
PV of Annual Cash Flow (B)	1,603
PV of Terminal Cash Flow "C"	0
Net Present Value	277

Due to Bonus depreciation there is an increase in NPV from 235 to 277