Question

Polycorp is considering the purchase of a machine for $600,000. The salvage value at the end of its three-year life is $100,000. Annual cash operating revenues are $700,000, $600,000 and $550,000 in years 1, 2 and 3, and cash expenses (before interest) are $300,000, $250,000 and $200,000 respectively. The machine will be depreciated for tax purposes using straight-line depreciation of 25% per year. Assume a corporate tax rate of 30% (tax is paid in the year the income is earned). The company requires a return of 12%pa after tax on this type of investment. A feasibility study was conducted last year at a cost of $210,000. The project will initially be financed using debt of $300,000 and $300,000 in equity. The loan is to be repaid over three years. The cost of debt is 8%pa. Calculate the NPV of this project. Should the project be accepted? Explain and defend your answer and calculations

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

Cell reference -

Project should be accepted because it has a positive net present value. Projects with positive npv increases the value of firm.