Question

Your firm is considering buying a machine for $10,000. The machine will produce annual cost savings of $3000 for the next five years. The machine will be depreciated over the 5 year period using the accelerated depreciation percentages allowed in the US (20%, 32%, 19.2%, 11.52%, 11.52%, 5.76% for each of the years 1,2,…,6). At the end of the sixth year, the machine will be sold for a salvage value of $4000. If the WACC is 12% and the tax rate is 35%, should this machine be bought?

Answer 1

Ref	Particulars		Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
a	Operating cash flow		$         3,000.00	$                 3,000.00	$         3,000.00	$         3,000.00	$         3,000.00	$                 -
	Gain on sale of asset							$     4,000.00
b	Depreciation		$        (2,000.00)	$               (3,200.00)	$       (1,920.00)	$       (1,152.00)	$       (1,152.00)	$       (576.00)
c=a-b	Profit before tax		$         1,000.00	$                   (200.00)	$         1,080.00	$         1,848.00	$         1,848.00	$     3,424.00
	Less: taxes		$             350.00	$                     (70.00)	$            378.00	$            646.80	$            646.80	$     1,198.40
	Profit after tax		$             650.00	$                   (130.00)	$            702.00	$         1,201.20	$         1,201.20	$     2,225.60
	Add: depreciation		$         2,000.00	$                 3,200.00	$         1,920.00	$         1,152.00	$         1,152.00	$        576.00
	Cash flow after tax		$         2,650.00	$                 3,070.00	$         2,622.00	$         2,353.20	$         2,353.20	$     2,801.60
d	Present value factor@ 12.0%		0.892857143	0.797193878	0.711780248	0.635518078	0.567426856	0.506631121
e=c*d	Present value of annual cashflows		$         2,366.07	$                 2,447.39	$         1,866.29	$         1,495.50	$         1,335.27	$     1,419.38
	Total present value of annual cash inflows		$       10,929.89
	Less: investment		$       10,000.00
	Working capital		$                      -
	NPV		$             929.89

As NPV is positive, machine can be bought.