Question

Bottoms Up diaper service is considering the purchase of a new industrial washer. it can purchase the washer for $3600 and sell its old washer for $900. The new washer will last for 6 years and save $1100 a year in expenses. the opportunity cost of capital is 20% and the firm's tax rate is 21%.

a. if the firm uses straight-line depreciationover a 6 year life, what are the cash flows of the project in years 0 to 6? The new washer will have zero salvage value after 6 years, and the old washer is fully depreciated .

b. What is the project NPV?

c. What is the NPV if the firm investment is entitled to immediate 100% bonus depreciation?

Answer 1

Initial Investment = Cost of New Washer - Sale Value of old washer

= 3,600 - 900

= $2,700

.

Depreciation p.a for 6 years = 2,700/6

= $450

.

Part-a:

Cash flows of the project in years 0 to 6

Year	Initial Investment	Before tax savings in expenses	After tax savings in expenses	Depreciation	Depreciation tax sheild	Cash Flows
0	-2,700	-	-	-	-	-2,700
1	-	1,100	869	450	94.5	963.5
2	-	1,100	869	450	94.5	963.5
3	-	1,100	869	450	94.5	963.5
4	-	1,100	869	450	94.5	963.5
5	-	1,100	869	450	94.5	963.5
6	-	1,100	869	450	94.5	963.5

.

.

Part-b:

Project NPV:

Year	Initial Investment	Before tax savings in expenses	After tax savings in expenses	Depreciation	Depreciation tax sheild	Cash Flows	DF @ 20%	Present Value
0	-2,700	-	-	-	-	-2,700	1	-2,700.00
1	-	1,100	869	450	94.5	963.5	0.833333	802.92
2	-	1,100	869	450	94.5	963.5	0.694444	669.10
3	-	1,100	869	450	94.5	963.5	0.578704	557.58
4	-	1,100	869	450	94.5	963.5	0.482253	464.65
5	-	1,100	869	450	94.5	963.5	0.401878	387.21
6	-	1,100	869	450	94.5	963.5	0.334898	322.67
							NPV:	504.13

.

.

Part-c:

NPV if the firm investment is entitled to immediate 100% bonus depreciation:

Year	Initial Investment	Before tax savings in expenses	After tax savings in expenses	Depreciation	Depreciation tax sheild	Cash Flows	DF @ 20%	Present Value
0	-2,700	-	-	-	-	-2,700	1	-2,700.00
1	-	1,100	869	2700	567	1,436.0	0.833333	1,196.67
2	-	1,100	869	0	0	869.0	0.694444	603.47
3	-	1,100	869	0	0	869.0	0.578704	502.89
4	-	1,100	869	0	0	869.0	0.482253	419.08
5	-	1,100	869	0	0	869.0	0.401878	349.23
6	-	1,100	869	0	0	869.0	0.334898	291.03
							NPV:	662.37