Question

Caspian Sea Drinks is considering the purchase of a new water filtration system produced by Rube Goldberg Machines. This new equipment, the RGM-7000, will allow Caspian Sea Drinks to expand production. It will cost $12.00 million fully installed and will be fully depreciated over a 20 year life, then removed for no cost. The RGM-7000 will result in additional revenues of $3.70 million per year and increased operating costs of $584,714.00 per year. Caspian Sea Drinks' marginal tax rate is 28.00%. If Caspian Sea Drinks uses a 10.00% discount rate, then the net present value of the RGM-7000 is _____.

Answer 1

Annual Operating cash flow (OCF)

Operating cash flow (OCF) = [(Revenue – Costs) x (1 – Tax rate)] + [Depreciation x Tax rate]

= [($3,700,000 - $584,714) x (1 – 0.28)] + [($12,000,000 / 20 Years) x 0.28]

= [$3,115,286 x 0.72] + [$600,000 x 0.28]

= $2,243,006 + $168,000

= $2,411,006

Project’s Net Present Value (NPV)

Year	Annual cash flows ($)	Present Value Factor (PVF) at 10.00%	Present Value of annual cash flows ($) [Annual cash flow x PVF]
1	2,411,006	0.909090909	2,191,823.56
2	2,411,006	0.826446281	1,992,566.88
3	2,411,006	0.751314801	1,811,424.43
4	2,411,006	0.683013455	1,646,749.48
5	2,411,006	0.620921323	1,497,044.99
6	2,411,006	0.564473930	1,360,949.99
7	2,411,006	0.513158118	1,237,227.26
8	2,411,006	0.466507380	1,124,752.06
9	2,411,006	0.424097618	1,022,501.87
10	2,411,006	0.385543289	929,547.15
11	2,411,006	0.350493899	845,042.87
12	2,411,006	0.318630818	768,220.79
13	2,411,006	0.289664380	698,382.53
14	2,411,006	0.263331254	634,893.21
15	2,411,006	0.239392049	577,175.65
16	2,411,006	0.217629136	524,705.13
17	2,411,006	0.197844669	477,004.67
18	2,411,006	0.179858790	433,640.61
19	2,411,006	0.163507991	394,218.73
20	2,411,006	0.148643628	358,380.67
TOTAL			20,526,252.53

Net Present Value (NPV) = Present Value of annual cash inflows – Initial Investment

= $20,526,252.53 - $12,000,000

= $8,526,252.53

Hence, the Net present value of the RGM-7000 will be $8,526,252.53

NOTE    

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.