Question

Oregon Forest Products will acquire new equipment that falls under the five-year MACRS category. The cost is $300,000. If the equipment is purchased, the following earnings before depreciation and taxes will be generated for the next six years. Use Table 12-12. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. Earnings before Depreciation Year 1 $ 110,000 Year 2 120,000 Year 3 75,000 Year 4 50,000 Year 5 56,000 Year 6 33,000 The firm is in a 35 percent tax bracket and has a 13 percent cost of capital. a. Calculate the net present value. (A negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places.) b. Under the net present value method, should Oregon Forest Products purchase the equipment asset? Yes No

Answer 1

a

Time line		0	1	2	3	4	5	6
Cost of new machine		-300000
=Initial Investment outlay		-300000
5 years MACR rate			20.00%	32.00%	19.20%	11.52%	11.52%	5.76%
Profits			110000	120000	75000	50000	56000	33000
-Depreciation	=Cost of machine*MACR%		-60000	-96000	-57600	-34560	-34560	-17280
=Pretax cash flows			50000	24000	17400	15440	21440	15720
-taxes	=(Pretax cash flows)*(1-tax)		32500	15600	11310	10036	13936	10218
+Depreciation			60000	96000	57600	34560	34560	17280
=after tax operating cash flow			92500	111600	68910	44596	48496	27498
+Tax shield on salvage book value	=Salvage value * tax rate							0
=Terminal year after tax cash flows								0
Total Cash flow for the period		-300000	92500	111600	68910	44596	48496	27498
Discount factor=	(1+discount rate)^corresponding period	1	1.13	1.2769	1.442897	1.6304736	1.8424352	2.0819518
Discounted CF=	Cashflow/discount factor	-300000	81858.41	87399.17	47758.087	27351.562	26321.686	13207.799
NPV=	Sum of discounted CF=	-16103.28967

b

Reject project as NPV is negative