Question

Nuff Folding Box Company, Inc. is considering purchasing a new gluing machine. The gluing machine costs $50,000 and requires installation costs of $2,500. This outlay would be partially offset by the sale of an existing gluer. The existing gluer originally cost $10,000 and is four years old. It is being depreciated under MACRS using a five-year recovery schedule and can currently be sold for $15,000. The existing gluer has a remaining useful life of five years. If held until year 5, the existing machine's market value would be zero. Over its five-year life, the new machine should reduce operating costs (excluding depreciation) by $17,000 per year. Training costs of employees who will operate the new machine will be a one-time cost of $5,000 which should be included in the initial outlay. The new machine will be depreciated under MACRS using a five-year recovery period. The firm has a 12 percent cost of capital and a 40 percent tax on ordinary income and capital gains.

a) The payback period for the project is ________.

b) The initial outlay for this project is ________.

c) The net present value of the project is ________.

need detailed calculation

Answer 1

a) Payback period of the project is calculated as follows,

Payback period =A+(B/C)

Where,

A means Last period with a negative cumulative cash flow

B means Absolute value of cumulative cash flow at the end of the period A

C means cash flow during the period after A

Year	Cash flows	Cumulative CF
0	(47,809)	(2,570)
1	14,400	(1,845)
2	16,920	(1,120)
3	14,232	(320)
4	12,619	1,080
5	12,619	2,480

Payback period =A+(B/C)

Payback period =3+(320/12,619)

Payback period =3.03 years

b) The initial outlay for this project is calculated as follows,

Particulars	Amount
Cost of machine including Installation cost	52,500
Add:Training cost	5,000
Less:After tax salvage value	9,691
The initial outlay	47,809

After tax salvage value of old machine is calculated as follows,

Particulars	Amount
Cost of Equipment	10,000
Total accumulated depreciation	8,272
Book value	1,728
Sale value	15,000
Gain on sale	13,272
Tax on Gain @ 40%	5,309
After tax Salvage value	9,691

Total accumulated depreciation of old machine is calculated as follows,

Particulars	Year 1	Year 2	Year 3	Year 4
Book value at the beginning of the year	10,000	8,000	4,800	2,880
Depreciation rate	20%	32%	19.20%	11.52%
Depreciation	2,000	3,200	1,920	1,152
Book value at the end of the year	8,000	4,800	2,880	1,728
Total accumulated depreciation	8,272

c) The net present value of the project is calculated as follows,

Particulars	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Revenue:
Sales	-	-	-	-	-	-
Expenses:
Manufacturing cost & Operating expenses	-	(17,000)	(17,000)	(17,000)	(17,000)	(17,000)
Depreciation	-	10,500	16,800	10,080	6,048	6,048
Taxable income (loss)	-	6,500	200	6,920	10,952	10,952
Less: Tax @ 40%	-	2,600	80	2,768	4,381	4,381
Net income (loss)	-	3,900	120	4,152	6,571	6,571
Depreciation	-	10,500	16,800	10,080	6,048	6,048
Investment activities
Cost of Equipment	(52,500)	-	-	-	-	-
Training cost	(5,000)	-	-	-	-	-
After tax Salvage value	9,691	-	-	-	-	-
Free cash flows	(47,809)	14,400	16,920	14,232	12,619	12,619
PV Factor @ 12%	1.00	0.89	0.80	0.71	0.64	0.57
PV of cash flows	(47,809)	12,857.14	13,488.52	10,130.06	8,019.73	7,160.47
NPV@ 12%	3,847.12

Depreciation of new machine is calculated as follows,

Particulars	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Book value at the beginning of the year	52,500	42,000	25,200	15,120	9,072	3,024
Depreciation rate	20%	32%	19.20%	11.52%	11.52%	5.76%
Depreciation	10,500	16,800	10,080	6,048	6,048	3,024
Book value at the end of the year	42,000	25,200	15,120	9,072	3,024	-