Question

Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $7,200 and sell its old washer for $2,100. The new washer will last for 6 years and save $1,700 a year in expenses. The opportunity cost of capital is 14%, and the firm’s tax rate is 40%. a. If the firm uses straight-line depreciation to an assumed salvage value of zero over a 6-year life, what is the annual operating cash flow of the project in years 0 to 6? The new washer will in fact have zero salvage value after 6 years, and the old washer is fully depreciated. (Negative amount should be indicated by a minus sign.) b. What is project NPV? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.) c. What is NPV if the firm uses MACRS depreciation with a 5-year tax life? Use the MACRS depreciation schedule. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Cost of new washer = $ 7200

Sales Value of old washer = $ 2100

Cost of Capital = 14% = 0.14

Tax Rate =40 % = 0.4

a)

Year	Cash Flow	Depreciation	Tax Savings on Depreciation	Operating Cash Flow = Cash Flow + Tax Savings
0	-5100 ( -7200 +2100 )	0		-5100
1	1700	1200	480	2180
2	1700	1200	480	2180
3	1700	1200	480	2180
4	1700	1200	480	2180
5	1700	1200	480	2180
6	1700	1200	480	2180

b)

= 2180 / ( 1.14)¹ + 2180 / ( 1.14)²+ 2180 / ( 1.14)³+ 2180 / ( 1.14)⁴ + 2180 / ( 1.14)⁵ +   2180 / ( 1.14)⁶ - 5100

= $ 3,377.30

c) 5 year tax life

Depreciation Schedule:

Year	Depreciation	Depreciation = 7200 * Depr. %
1	20%	1440
2	32%	2304
3	19.20%	1382.4
4	11.52%	829.44
5	11.52%	829.44
6	5.76%	414.72

Since, it is 5-year tax life, tax savings will be only for 5 years

Year	Cash Flow	Depreciation	Tax Savings on Depreciation	Operating Cash Flow = Cash Flow + Tax Savings
0	-5100	0		-5100
1	1700	1440	576.00	2276.00
2	1700	2304	921.60	2621.60
3	1700	1382.4	552.96	2252.96
4	1700	829.44	331.78	2031.78
5	1700	829.44	331.78	2031.78
6	1700	414.72	0	1700

= 2276 / ( 1.14)¹ + 2621.6 / ( 1.14)²+ 2252.96 / ( 1.14)³+ 2031.78 / ( 1.14)⁴ +

2031.78 / ( 1.14)⁵ + 1700 / ( 1.14)⁶ - 5100

= $ 3,467.12