Question

Andover Enterprises is considering the purchase of a new forklift for $350,000. The firm's old forklift has a book value of $85,000, but has a current market value of $60,000. It is being depreciated on a straight-line basis at the rate of $21,250 per year (and, as result, will be fully depreciated in 4 years). Its salvage value is expected to be $20,000 at the end of 5 years.

The new forklift will be depreciated using the 5-year MACRS schedule. It is expected to have a salvage value of $80,000 at the end of 5 years, at which time it will be sold. The new forklift is expected to increase revenues by $63,000 for each of the next 5 years. In addition, operating expenses will be reduced by $32,000 for each of the next five years.

Andover's marginal tax rate is 40 percent. Its marginal cost of capital is 15 percent.

Should Andover buy the new forklift?

Answer 1

In case Old Forklift is continued:

Year	Depreciation (Note -1)	Tax at 40%	Savings after Tax	Cost of Capital - 15% (Note - 2)	Total Cashflows
1	-21250	8500	-12750	0.87	-11,086.96
2	-21250	-8500	-29750	0.76	-22,495.27
3	-21250	-8500	-29750	0.66	-19,561.11
4	-21250	-8500	-29750	0.57	-17,009.66
5	-21250	-8500	-29750	0.50	-14,791.01
				Total	-84,944.01
				Salvage value end of 5th year	20,000.00
				NPV	-64,944

In case New Forklift is purchased:

Year	Increase in Revenue	Savings of Operating Expenses	Depreciation (Note -3)	Total Savings	Tax at 40%	Savings after Tax	Cost of Capital - 15%	Total Cashflows
1	63000	32000	-54000	41000	-16400	24600	0.87	21,391.30
2	63000	32000	-54000	41000	-16400	24600	0.76	18,601.13
3	63000	32000	-54000	41000	-16400	24600	0.66	16,174.90
4	63000	32000	-54000	41000	-16400	24600	0.57	14,065.13
5	63000	32000	-54000	41000	-16400	24600	0.50	12,230.55
							Total	82,463.02
							Salvage value end of 5th year	80,000.00
							Market Value of old forklift	60,000.00
							Total Inflows	2,22,463.02
							Cost of New Forklift	3,50,000.00
							NPV	-1,27,536.98

As Net Present Value in purchasing of New Forklift is higher, Andover should not buy the New Forklift.

Note -1:

Depreciation is 21,250 for 5 years as per straight line Method.

Note -2:

Year	Cost of Capital - 15%
1	0.87
2	0.76
3	0.66
4	0.57
5	0.50

Note -3:

Particulars	Amount
Total Cost	3,50,000.00
Salvage Value	80,000.00
Total	2,70,000.00
Life	5
Depreciation	54,000.00