Question

Based on the following, should we buy this new digital printing system? Use the table below to plan your cash flows. Bold boxes are where #’s should go.

• Initially cost $1 million.
• It will save $300,000/yr (pre-tax) in inventory and receivables management costs.
• The system will last for 5 years. Depreciation is 20% year. Salvage value of $50,000. Assume a straight line depreciation approach.
• No impact on net working capital.

• The marginal tax rate is 40%.
• The required return is 8%.

Cash Flows
Year	PV	0	1	2	3	4	5
Equipment Cost
After Tax Savings
Total Cash Flows
Depreciation Tax Shield (Benefit)
NPV

Answer 1

Initial Outflow (Equipment cost )=$1,000,000 Straight Line depreciation = Value of asset/life of the asset. Depreciation =20% that is $1,000,000*.2=$200,000.Depreciation Tax shield =Tax rate *Depreciation Expense =40%*200,000=$80,000 this would be the same for all 5 years.

Cashflows

Pretax Savings =$300,000 Less tax depreciation chages =$200,000 we get Net effect before taxes =$100,000,Less Tax (40%)=$40,000 we get Net effect after taxes =$60,000 Adding back tax depreciation charges $200,000 we get After tax cashflows=$260,000.

In year five the disposal cashflow would be added o the after tax savings .Disposal Cashflow=$50,000 Less Tax rate (40%) $20,000 we get disposal cashflow= $30,000.So Year 5 cashflow =$260,000+$30000=$290,000

NPV =Total PV of Inflows(savings in this case)-Initial Outflow .RRR=8%

total PV of savings(after tax savings *PV factor for the respective years dicounted at 8%) =

Year 1 $260,000*.9259=$240,734 + Year 2 $260,000*.85734=$222,908.4 +Year 3

$260,000*.79383=$206,395.8 + Year 4 =$260,000*.73503 = $191,107.8 + Year % =$290,000*.68058 = $197,368.Total Pv of after tax savings =$1,058,514.2 . NPV =$1,058,514.2-$1,000,000=$58514.2

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