Question

A company is deciding whether to lease or purchase an asset. In this question we will evaluate the NPV of the purchase decision.

The capital cost required to purchase the asset is $1,000,000 (at time zero) with a salvage value of $500,000 at the end of the 5th year. The purchased asset can be depreciated based on MACRS 5-year life depreciation with the half year convention (table A-1 at IRS) over six years (from year 0 to year 5).

The asset would yield annual revenue of $350,000 for five years (from year 1 to year 5) and operating cost of $60,000 for year 1 to 5. If the income tax is 40% and the annual discount rate is 16%, calculate the NPV for the purchase decision

Answer 1

	0	1	2	3	4	5
Annual revenue		$ 3,50,000	$    3,50,000	$ 3,50,000	$   3,50,000	$      3,50,000
Operating cost		$     60,000	$        60,000	$     60,000	$       60,000	$          60,000
Depreciation		$ 2,00,000	$    3,20,000	$ 1,92,000	$   1,15,200	$      1,15,200
NOI		$     90,000	$      -30,000	$     98,000	$   1,74,800	$      1,74,800
Tax at 40%		$     36,000	$      -12,000	$     39,200	$       69,920	$          69,920
NOPAT		$     54,000	$      -18,000	$     58,800	$   1,04,880	$      1,04,880
Add: Depreciation		$ 2,00,000	$    3,20,000	$ 1,92,000	$   1,15,200	$      1,15,200
OCF		$ 2,54,000	$    3,02,000	$ 2,50,800	$   2,20,080	$      2,20,080
Capital expenditure	$     10,00,000
After tax salvage value =-((500000-(500000-57600)*40%)) =						$     -3,23,040
FCF	$   -10,00,000	$ 2,54,000	$    3,02,000	$ 2,50,800	$   2,20,080	$      5,43,120
PVIF at 16% [PVIF = 1/1.16^n]	1	0.86207	0.74316	0.64066	0.55229	0.47611
PV at 16%	-1000000	218966	224435	160677	121548	258587
NPV	-15788