Question

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You must evaluate the purchase of a spectrometer for a firm. The base price is $140,000...

You must evaluate the purchase of a spectrometer for a firm. The base price is $140,000 and it would cost another $30,000 to modify the equipment for special use by the firm.

The equipment will be depreciated to zero value over the 3 years using prime cost (straight line) method. The machine would be sold after 3 years for $60,000. The machine would require a $8,500 increase in net working capital and fully recover at the end of its 3-year life. The equipment should save the firm $50,000 per year in before-tax labor costs.

Below shows the forecasted sales revenues, variable cost and fixed cost.

Year 1

Year 2

Year 3

Sales quantity (units)

4,000

5,000

5,500

Selling price per unit

$4

$4

$4

Fixed cost of production (per year)

$1,500

$1,500

$1,500

Variable cost of production (per unit)

$1.1

$1.1

$1.1

The marginal tax rate is 40% and the discount rate is 10%.

What is the net present value (NPV) of the proposed project?   

Solutions

Expert Solution

(a.) Calculation of Net present value (NPV) of the proposed project :

Year 0 Year 1 Year 2 Year 3
Initial Investment ( 140000 + 30000) 170000
Saving in Pre tax Labour Cost 50000 50000 50000
Sales (Quantity * Selling Price) 16000 20000 22000
Less :Variable cost of Production (Quantity * Variable cost per unit) 4400 5500 6050
Less :Fixed Cost of Production 1500 1500 1500
Less : Depreciation (170000 / 3 ) 56666.67 56666.67 56666.67
Earning before taxes 3433.333 6333.333 7783.333
Taxes @ 40% -1373.33 -2533.33 -3113.33
Earnings After Taxes 2060 3800 4670
Add : Depreciation 56666.67 56666.67 56666.67
Plus : Salvage Value 60000
Less : tax on salvage @ 40% 24000
NWC 8500
Plus : Recapture of NWC 8500
Operating Cash Flows 178500 58727 60467 105836.7
PV Factor @ 10% 1 0.909091 0.826446 0.751315
PV of Net Cash flows (Inflow) 53387.88 49972.45 79516.65
PV of Net Cash flows (Outflow) 178500
The net present value (NPV) of this project is         = $ 4376.9847 or $ 4376.98
NPV = PV of cash inflow - PV of cash outflow
        = 182879.9847- 178500
        = $ 4376.9847 or $ 4376.98
Working Note :
Book Value = 0 (Since it is fully depreciated
Gain on Sale = Salvage Value - Book Value
                          = 60000- 0
                          = 60000
Tax on Gain on Sale = 60000 * 0.4 = 24000

jeff jeffy answered 1 year ago
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