Question

Oxygen Optimization is considering buying a new purification system. The new system would be purchased today for 16,200 dollars. It would be depreciated straight-line to 2,000 dollars over 2 years. In 2 years, the system would be sold and the after-tax cash flow from capital spending in year 2 would be 2,900 dollars. The system is expected to reduce costs by 4,500 dollars in year 1 and by 12,200 dollars in year 2. If the tax rate is 50 percent and the cost of capital is 5.07 percent, what is the net present value of the new purification system project?

Question 8

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Fairfax Pizza is considering buying a new oven. The new oven would be purchased today for 16,200 dollars. It would be depreciated straight-line to 2,200 dollars over 2 years. In 2 years, the oven would be sold for an after-tax cash flow of 3,400 dollars. Without the new oven, costs are expected to be 10,600 dollars in 1 year and 16,300 in 2 years. With the new oven, costs are expected to be -600 dollars in 1 year and 13,200 in 2 years. If the tax rate is 50 percent and the cost of capital is 11.11 percent, what is the net present value of the new oven project?

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Answer 1

1. Cost of project= 16,200. Given salvage value of 2000 after 2 years, dep per year as per straight line method = (16200-2000)/2= 7100 is th deprecaition for 2 years.

CF0= -16200 (Since investment has been done)

CF1= EBITDA*(1-T) + DEP*T = 4500*(1-0.5) + 7100* (1-0.5)= 5800

CF2= EBITDA*(1-T) + DEP*T+ Money from sale of asset*(1-) = 6100+ 3550+ 2900 (since 2900 are after tax cash flows from sale of asset)

so, CF2= 12,550

Given , discount rate as 5.07%, compute present value as PVCF1= 5800/1.0507= 5520.1294

CF2= 12550/ (1.0507)^2= 11,368.0574

So net presenr value = -16200+5520.1294+11,368.0574= 688.18

2. Cost of project= 16,200. Given salvage value of 2200 after 2 years, dep per year as per straight line method = (16200-2200)/2= 7000 is th depreciation for 2 years.

CF0= -16200 (Since investment has been done)

CF1= EBITDA*(1-T) + DEP*T = 600*(1-0.5) + 7000* (1-0.5)= 3800

CF2= EBITDA*(1-T) + DEP*T+ Money from sale of asset*(1-) = 3100+ 3500+ 3400 (since 3400 are after tax cash flows from sale of asset)

so, CF2= 8450

Given , discount rate as 11.11%, compute present value as PVCF1== 3800/1.11= 3423.423

CF2= 8450/ (1.11)^2= 6858.209

So net presenr value = -16200+3423.423+6858.209 = -5918.36