Question

Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $8,400 and sell its old washer for $2,400. The new washer will last for 6 years and save $2,400 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 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 immediate 100% bonus depreciation? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

(a)

Calculation of Cashflow
Year	0	1	2	3	4	5	6
Saving	-	$2,400	$2,400	$2,400	$2,400	$2,400	$2,400
Less : Depreciation	-	$1,400	$1,400	$1,400	$1,400	$1,400	$1,400
EBT	-	$1,000	$1,000	$1,000	$1,000	$1,000	$1,000
Less : Tax @21%	-	$210	$210	$210	$210	$210	$210
EAT	-	$790	$790	$790	$790	$790	$790
Add : Depreciation	-	$1,400	$1,400	$1,400	$1,400	$1,400	$1,400
Cashflow after tax	-	$2,190	$2,190	$2,190	$2,190	$2,190	$2,190
Less : Cost of new washer	$8,400	-	-	-	-	-	-
Add : Salvage of old machine	$1,896	-	-	-	-	-	-
Net Cashflow	- $6,504	$2,190	$2,190	$2,190	$2,190	$2,190	$2,190

Depreciation = Coast of machine / Life of Machine = $8,400 / 6 Years = $1,400

Salvage value of old machine = Salvage x (1-t) = $2,400 x (1-0.21) = $2,400 x 0.79 = $1,896 (Old machine fully depreciated so sell price is capital gain.

(b)

Calculation of NPV
Year	Cashflow	DF @19%	P.V.
0	- $6,504	1.0000	- $6,504.000
1	$2,190	0.8403	$1,840.257
2	$2,190	0.7062	$1,546.578
3	$2,190	0.5934	$1,299.546
4	$2,190	0.4987	$1,092.153
5	$2,190	0.4190	$917.610
6	$2,190	0.3521	$771.099
Net Present Value	$963.24

(c)

Calculation of NPV
Year	Cashflow	DF @19%	P.V.
0	-$6,504	1.0000	- $6,504.000
1	$3,660	0.8403	$3,075.498
2	$1,896	0.7062	$1,338.955
3	$1,896	0.5934	$1,125.086
4	$1,896	0.4987	$945.535
5	$1,896	0.4190	$794.424
6	$1,896	0.3521	$667.582
Net Present Value	$1,443.08

Calculation of Cashflow
Year	0	1	2	3	4	5	6
Saving	-	$2,400	$2,400	$2,400	$2,400	$2,400	$2,400
Less : Depreciation	-	$8,400	$0	$0	$0	$0	$0
EBT	-	-$6,000	$2,400	$2,400	$2,400	$2,400	$2,400
Less : Tax @21%	-	-$1,260	$504	$504	$504	$504	$504
EAT	-	-$4,740	$1,896	$1,896	$1,896	$1,896	$1,896
Add : Depreciation	-	$8,400	$0	$0	$0	$0	$0
Cashflow after tax	-	$3,660	$1,896	$1,896	$1,896	$1,896	$1,896
Less : Cost of new washer	$8,400	-	-	-	-	-	-
Add : Salvage of old machine	$1,896	-	-	-	-	-	-
Net Cashflow	-$6,504	$3,660	$1,896	$1,896	$1,896	$1,896	$1,896

Depreciation = Coast of machine x 100% bonus depreciation = $8,400 x 100% = $8,400

Salvage value of old machine = Salvage x (1-t) = $2,400 x (1-0.21) = $2,400 x 0.79 = $1,896 (Old machine fully depreciated so sell price is capital gain.