Question

Johnny’s Lunches is considering purchasing a new, energy-efficient grill. The grill will cost $37,000 and will be depreciated according to the 3-year MACRS schedule. It will be sold for scrap metal after 3 years for $9,250. The grill will have no effect on revenues but will save Johnny’s $18,500 in energy expenses per year. The tax rate is 40%. Use the MACRS depreciation schedule.

a. What are the operating cash flows in each year? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

b. What are the total cash flows in each year? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

c. Assuming the discount rate is 11%, calculate the net present value (NPV) of the cash flow stream. Should the grill be purchased? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Time line		0	1	2	3
Cost of new machine		-37000
=Initial Investment outlay		-37000
3 years MACR rate			33.33%	44.45%	14.81%	7.41%
Savings			18500	18500	18500
-Depreciation	=Cost of machine*MACR%		-12332.1	-16446.5	-5479.7	2741.7	=Salvage Value
=Pretax cash flows			6167.9	2053.5	13020.3
-taxes	=(Pretax cash flows)*(1-tax)		3700.74	1232.1	7812.18
+Depreciation			12332.1	16446.5	5479.7
=a. after tax operating cash flow			16032.84	17678.6	13291.88
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				5550
+Tax shield on salvage book value	=Salvage value * tax rate				1096.68
=Terminal year after tax cash flows					6646.68
b. Total Cash flow for the period		-37000	16032.84	17678.6	19938.56
Discount factor=	(1+discount rate)^corresponding period	1	1.11	1.2321	1.367631
Discounted CF=	Cashflow/discount factor	-37000	14444	14348.3483	14578.903
c. NPV=	Sum of discounted CF=	6371.25