Question
In: Finance
A company is buying a new system. It would cost $600,000 today. Depreciate straight line to...
A company is buying a new system. It would cost $600,000 today.
Depreciate straight line to $0 over 2 years, and hauled away for
nothing, so the after-tax cash flow would be $0 in year 2.
The system is expected to reduce costs by 400,000 in year 1 and
400,000 in year 2.
If the tax rate is 30% and the cost of capital is 10% what is the
NPV of the system?
Solutions
Expert Solution
| Year 0 | Year 1 | Year 2 | |
| Savings in cost | - | 400,000 | 400,000 |
| Less: Depreciation | - | 300,000 | 300,000 |
| Profit before tax | - | 100,000 | 100,000 |
| Tax at 30% | - | 30,000 | 30,000 |
| Profit after tax | - | 70,000 | 70,000 |
| Add back depreciation | - | 300,000 | 300,000 |
| Cash flow after tax | - | 370,000 | 370,000 |
| Initial Investment | (600,000) | - | - |
| Total Cash flow | (600,000) | 370,000 | 370,000 |
| Discount Factor at 10% | 1 | 0.909091 | 0.826446 |
| Disconted Cash flow | (600,000) | 336,363.64 | 305,785.12 |
| NPV = | 42,148.76 |
NPV = Sum of discounted cash inflow - cash outflow
We add back depreciation because it is a non cash expense.
Straight line depreciation = Cost of asset / Useful life
Excel formulas:
Discount Factor formula without excel:
Where,
i = rate of return
n = number of periods
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