Question

Consider the case of DropIt Fast Parcel Company, working hard during the Corona virus lockdown. Dropit Fast is considering purchasing some new equipment to replace existing equipment ( i.e. delivery car) that has a book value of zero, but market value of $15,000 The new equipment costs $90,000 and is expected to provide production savings and increased profits of $20,000 per year for the next ten years. The new equipment has an expected useful life of ten years, after which the estimated salvage value would be $10,000. Asuming straight-line depreciation, a 34% effective tax rate, and a cost of capital (i.e. discount rate) of 12%, should DropIt Fast replace the equipment/car?

Answer 1

Answer :

Calculation of Net Present Value

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8	Year 9	Year 10
Initial Investment	90000
Saving in Production		20000	20000	20000	20000	20000	20000	20000	20000	20000	20000
Less : Depreciation [(90000 - 10000) / 10 ]		8000	8000	8000	8000	8000	8000	8000	8000	8000	8000
Earning before taxes		12000	12000	12000	12000	12000	12000	12000	12000	12000	12000
Taxes @ 34%		-4080	-4080	-4080	-4080	-4080	-4080	-4080	-4080	-4080	-4080
Earnings After Taxes		7920	7920	7920	7920	7920	7920	7920	7920	7920	7920
Add : Depreciation		8000	8000	8000	8000	8000	8000	8000	8000	8000	8000
Plus : Salvage Value											10000
Sale Value of Old Machine ( Net of Taxes)	-9900
Operating Cash Flows	80100	15920	15920	15920	15920	15920	15920	15920	15920	15920	25920
PV Factor @ 12%	1	0.892857	0.797194	0.71178	0.635518	0.567427	0.506631	0.452349	0.403883	0.36061	0.321973
PV of Net Cash flows (Inflow)		14214.29	12691.33	11331.54	10117.45	9033.436	8065.567	7201.4	6429.821	5740.912	8345.546
PV of Net Cash flows (Outflow)	80100
The net present value (NPV) of this project is		= $ 13071.28 or $ 13071.28
NPV = PV of cash inflow - PV of cash outflow
= 93171.28298- 80100
= $ 13071.28 or $ 13071.28
Book Value of old machine= 0
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