Question

Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $7,800 and sell its old washer for $1,600. The new washer will last for 6 years and save $2,300 a year in expenses. The opportunity cost of capital is 17%, 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 year 0 Cash flows

Cash flow year 0 =Purchase cost of new machine-After tax selling cost of old machine

-$7,800+$1,600(1-0.21)

=-$7,800+$1,264 = ($6,536)

Cash flows for year 1 to year 6 (each year cash flow will be same as follows)

Particulars	Amount $
Saving in expenses each year	2,300
Less: depreciation 7,800/6yrs	1,300
Saving before tax	1,000
Less: tax @21%	2,10
Saving after tax	790
Add: depericiation	1,300
Cash flows year 1 to 6 (each year)	2,090

(b) calculation of NPV

NPV = -initial cost + Cash flows*(PVIF17% for 6years)

NPV = - $6,536 + $2,090(PVIF17% for 6 years)

NPV = - $6,536 + $2,090*3.5892 = $965.40

(c) NPV if 100% immediate bonus depreciation

Initial Cost would be as follows

initial cost of new machine	7,800
Less: after tax value of old machine	1,264
Less: tax saving bonus depreciation 7,800*21%	1,638
Net initial cost	4,898

After tax saving each year = 2,300(1 - 0.21) = $1,817

NPV = - $4,898 + 1,817*(PVIF17% for 6 years)

NPV = - $4,898 + 1,817*3.5892 = $1,623.55