Question

As a financial manager, you are considering purchasing a new machine that will cost $1 million. It can be depreciated on a straight-line basis for five years to a zero salvage value. You expect revenues from the machine to be $700,000 each year and expenses are expected to be 50% of revenue. If the company is taxed at a rate of 34% and the appropriate discount rate for a project of this level of risk is 15%, will the company invest in this new machine? Please show work with formulas, not Excel.

Answer 1

Belo is tha calculation of NPV:

Particulars	Remark	0	1	2	3	4	5
Revenue	Given		7,00,000.00	7,00,000.00	7,00,000.00	7,00,000.00	7,00,000.00
Cost	50% of revenue		3,50,000.00	3,50,000.00	3,50,000.00	3,50,000.00	3,50,000.00
EBITDA	Revenue- Cost		3,50,000.00	3,50,000.00	3,50,000.00	3,50,000.00	3,50,000.00
Depreciation	1000000/5 = 200000		2,00,000.00	2,00,000.00	2,00,000.00	2,00,000.00	2,00,000.00
EBT	EBITDA-Depreciation		1,50,000.00	1,50,000.00	1,50,000.00	1,50,000.00	1,50,000.00
Tax	34% x EBT		51,000.00	51,000.00	51,000.00	51,000.00	51,000.00
EAT	EBT-Tax		99,000.00	99,000.00	99,000.00	99,000.00	99,000.00
Depreciation	Added back as non cash		2,00,000.00	2,00,000.00	2,00,000.00	2,00,000.00	2,00,000.00
OCF	EAT+Depreciation		2,99,000.00	2,99,000.00	2,99,000.00	2,99,000.00	2,99,000.00
FCINV	Given	-10,00,000.00
FCF	OCF+FCINV	-10,00,000.00	2,99,000.00	2,99,000.00	2,99,000.00	2,99,000.00	2,99,000.00
Discount factor Formula	at 15 %	1/(1+0.15)^0	1/(1+0.15)^1	1/(1+0.15)^2	1/(1+0.15)^3	1/(1+0.15)^4	1/(1+0.15)^5
Discount factor	Calculated using above formula	1.00	0.87	0.76	0.66	0.57	0.50
DCF	FCF x Discount Factor	-10,00,000.00	2,60,000.00	2,26,086.96	1,96,597.35	1,70,954.22	1,48,655.84
NPV = sum of all DCF	2,294.37

So the NPV is positive and therefore the machine should be invested in.