Ilana Industries, Inc., needs a new lathe. It can buy a new high-speed lathe for $1.9...

Ilana Industries, Inc., needs a new lathe. It can buy a new high-speed lathe for $1.9 million. The lathe will cost $44,000 per year to run, but it will save the firm $196,000 in labor costs and will be useful for 10 years. Suppose that for tax purposes, the lathe will be depreciated on a straight-line basis over its 10-year life to a salvage value of $380,000. The actual market value of the lathe at that time also will be $380,000. The discount rate is 11%, and the corporate tax rate is 20%. What is the NPV of buying the new lathe?

Expert Solution

Time line		0	1	2	3	4	5	6	7	8	9	10



Cost of new machine		-1900000

=Initial Investment outlay		-1900000

													1

Savings			196000	196000	196000	196000	196000	196000	196000	196000	196000	196000

Operating cost			-44000	-44000	-44000	-44000	-44000	-44000	-44000	-44000	-44000	-44000
-Depreciation	(Cost of equipment-salvage value)/no. of years		-152000	-152000	-152000	-152000	-152000	-152000	-152000	-152000	-152000	-152000	380000	=Salvage Value

=Pretax cash flows			0	0	0	0	0	0	0	0	0	0
-taxes	=(Pretax cash flows)*(1-tax)		0	0	0	0	0	0	0	0	0	0
+Depreciation			152000	152000	152000	152000	152000	152000	152000	152000	152000	152000
=after tax operating cash flow			152000	152000	152000	152000	152000	152000	152000	152000	152000	152000



+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)											304000
+Tax shield on salvage book value	=Salvage value * tax rate											76000
=Terminal year after tax cash flows												380000

Total Cash flow for the period		-1900000	152000	152000	152000	152000	152000	152000	152000	152000	152000	532000
Discount factor=	(1+discount rate)^corresponding period	1	1.11	1.2321	1.367631	1.5180704	1.6850582	1.8704146	2.07616	2.30454	2.558037	2.839421
Discounted CF=	Cashflow/discount factor	-1900000	136936.94	123366.61	111141.09	100127.11	90204.602	81265.407	73212.08	65956.8	59420.57	187362.1
NPV=	Sum of discounted CF=	-871006.63

jeff jeffy answered 2 years ago

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