Question

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a) A new operating system for an existing machine is expected to cost $750,000 and have a useful life of six years. The system yields an incremental after-tax income of $195,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $22,400.

b) A machine costs $470,000, has a $37,100 salvage value, is expected to last eight years, and will generate an after-tax income of $66,000 per year after straight-line depreciation.

Assume the company requires a 12% rate of return on its investments. Compute the net present value of each potential investment. (PV of $1, FV of $1, PVA of $1, and FVA of $1) (Use appropriate factor(s) from the tables provided.)

Required A

A new operating system for an existing machine is expected to cost $750,000 and have a useful life of six years. The system yields an incremental after-tax income of $195,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $22,400. (Round your answers to the nearest whole dollar.)

Cash Flow Select Chart Amount x PV Factor = Present Value Annual cash flow = $0 Residual value = 0 Net present value Required B A machine costs $470,000, has a $37,100 salvage value, is expected to last eight years, and will generate an after-tax income of $66,000 per year after straight-line depreciation. (Round your answers to the nearest whole dollar.) Cash Flow Select Chart Amount x PV Factor = Present Value Annual cash flow = $0 Residual value = 0 Net present value

Answer 1

Requirement - 1

Annual cash flow = After Tax Income + Depreciation

Depreciation = [ Cost – Salvage Value ] / Useful Life

= [ $750,000 – 22400 ] / 6 Years

= $121,267

Annual cash flow = $ 195,000 + 121,267 = $316,267

	N=	6 Years
	I=	12%
Cash flow	Select chart	Amount	PV Factor	Present Value
Annual cash flow	Present value of annuity of $1	$316,267	4.11141	$13,00,303
Residual Value	Present Value of $1	$22,400	0.50663	$11,348
	Present Value of cash inflows			$13,11,651
	Present Value of cash outflows			$750,000
	Net Present Value			$5,61,651

Requirement - 2

Annual cash flow = After Tax Income + Depreciation

Depreciation = [ Cost – Salvage Value ] / Useful Life

= [ $470,000 – 37100 ] / 8 Years

= $ 54,113

Annual cash flow = $ 66,000 + 54113 = $ 120,113

	N=	8 Years
	I=	12%
Cash flow	Select chart	Amount	PV Factor	Present Value
Annual cash flow	Present value of annuity of $1	$ 120,113	4.96764	$5,96,678
Residual Value	Present Value of $1	$37,100	0.40388	$14,984
	Present Value of cash inflows			$611,662
	Present Value of cash outflows			$470,000
	Net Present Value			$141,662