Question

A company is considering the purchase of equipment costing $84000 which will permit it to reduce its existing labour cost by $21000 each year for twelve years. The company estimates that it will have to spend $2000 every two years overhauling the equipment. The equipment may be depreciated using straight line depreciation over 12 years for tax purposes. The company tax rate is 30 cents in the dollar and the after corporate tax cost of capital is 10% per annum.

Assume:

1. Salvage value of zero.

2. The outlay of $84000 occurs at time zero.

3. All other cash flows including, tax payments and credits are made at the end of the year.

4. No overhaul is required in year 12.

What is the NPV to the nearest dollar? Be careful not to round until the last calculation.

This question has been answered previously but the calculation is wrong.

Answer 1

NPV= $26374

Workings

Labour cost saving is after tax = 21000*(1-30%)

Overhaul cost is after tax

Tax shield on depreciation = Initial cost*Tax rate/12

Year	Initial cost	Labour cost after tax	Overhaul cost	Tax shield on depreciation	Net cash flow
0	-84000				-84000
1		14700		2100	16800
2		14700	-1400	2100	15400
3		14700		2100	16800
4		14700	-1400	2100	15400
5		14700		2100	16800
6		14700	-1400	2100	15400
7		14700		2100	16800
8		14700	-1400	2100	15400
9		14700		2100	16800
10		14700	-1400	2100	15400
11		14700		2100	16800
12		14700		2100	16800
				NPV	26373.64