Question

LM Company is considering investing in a new project that will generate cash inflows of $45,000 every year for the ten-year life of the project. Investing in this new project will require the purchase of a new machine, which will cost $200,000. The machine will have a salvage value of $15,000 at the end of ten years, but will require a repair costing $6,000 at the end of year four and a repair costing $10,000 at the end of year seven. In addition, this project will require an immediate investment of $40,000 in working capital which would be released for investment elsewhere at the end of the ten years. LM Company has a cost of capital of 8% and an income tax rate of 40%. Calculate the net present value (NPV) of the new project.

Answer 1

Solution:

Computation of Present value after tax cash Inflows
Particulars	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8	Year 9	Year 10	Total
Cash Inflows	$45,000.00	$45,000.00	$45,000.00	$45,000.00	$45,000.00	$45,000.00	$45,000.00	$45,000.00	$45,000.00	$45,000.00
Less: Depreciation	$18,500.00	$18,500.00	$18,500.00	$18,500.00	$18,500.00	$18,500.00	$18,500.00	$18,500.00	$18,500.00	$18,500.00
Less: repair				$6,000.00			$10,000.00
Income before taxes	$26,500.00	$26,500.00	$26,500.00	$20,500.00	$26,500.00	$26,500.00	$16,500.00	$26,500.00	$26,500.00	$26,500.00
Less: Income Tax (40%)	$10,600.00	$10,600.00	$10,600.00	$8,200.00	$10,600.00	$10,600.00	$6,600.00	$10,600.00	$10,600.00	$10,600.00
Income after taxes	$15,900.00	$15,900.00	$15,900.00	$12,300.00	$15,900.00	$15,900.00	$9,900.00	$15,900.00	$15,900.00	$15,900.00
Add: Depreciation	$18,500.00	$18,500.00	$18,500.00	$18,500.00	$18,500.00	$18,500.00	$18,500.00	$18,500.00	$18,500.00	$18,500.00
Add: Salvage value of machine										$15,000.00
Add: recovery of working capital										$40,000.00
Annual cash inflows	$34,400.00	$34,400.00	$34,400.00	$30,800.00	$34,400.00	$34,400.00	$28,400.00	$34,400.00	$34,400.00	$89,400.00
PV Factor	0.92593	0.85734	0.79383	0.73503	0.68058	0.63017	0.58349	0.54027	0.50025	0.46319
Present value of cash inflows	$31,851.85	$29,492.46	$27,307.83	$22,638.92	$23,412.06	$21,677.84	$16,571.13	$18,585.25	$17,208.56	$41,409.50	$250,155.39

Initital Cash outflows = Investment in machine + Working captial investment = $200,000 + $40,000 = $240,000

NPV = PV of cash inflows - Iniital Cash outflows

= $250,155.39 - $240,000 = $10,155.39