Question

AMT, Inc., is considering the purchase of a digital camera for maintenance of design specifications by feeding digital pictures directly into an engineering workstation where computer-aided design files can be superimposed over the digital pictures. Differences between the two images can be noted, and corrections, as appropriate, can then be made by design engineers.

a. You have been asked by management to determine the PW of the EVA of this equipment, assuming the following estimates: capital investment = $346,000; market value at end of year six = $115,000; annual revenues = $127,000; annual expenses = $7,000; equipment life = 6 years; effective income tax rate = 22%; and after-tax MARR = 9% per year. MACRS depreciation will be used with a five-year recovery period.

b. Compute the PW of the equipment's ATCFs.

Answer 1

Working notes:

(i) MACRS method ignores salvage value. MACRS depreciation schedule:

Year	Equipment cost ($)	Depreciation Rate	Annual Depreciation ($)
1	3,46,000	20	69,200
2	3,46,000	32	1,10,720
3	3,46,000	19.2	66,432
4	3,46,000	11.52	39,859
5	3,46,000	11.52	39,859
6	3,46,000	5.76	19,930

(ii)

Annual income, years 1-5 = Revenue - Cost = 127,000 - 7,000 = 120,000

Annual income, year 6 = 120,000 + 115,000 Market value = 235,000

(iii)

Taxable income (TI) = Annual income - Depreciation (D)

(iv)

After-tax income (NI) = TI x (1 - Tax rate) = TI x (1 - 0.22) = TI x 0.78

(v)

After-tax cash flow (ATCF) = NI + D

(vi)

PV factor in year N = (1.09)^-N.

Therefore,

PW of ATCF computed as follows.

Year	Income ($)	D ($)	TI ($)	NI ($)	ATCF ($)	PV Factor @9%	Discounted ATCF ($)
0					-3,46,000	1.0000	-3,46,000
1	1,20,000	69,200	50,800	39,624	1,08,824	0.9174	99,839
2	1,20,000	1,10,720	9,280	7,238	1,17,958	0.8417	99,283
3	1,20,000	66,432	53,568	41,783	1,08,215	0.7722	83,562
4	1,20,000	39,859	80,141	62,510	1,02,369	0.7084	72,521
5	1,20,000	39,859	80,141	62,510	1,02,369	0.6499	66,533
6	2,35,000	19,930	2,15,070	1,67,755	1,87,685	0.5963	1,11,910
						PW of ATCF ($) =	1,87,647