Question

a. A new operating system for an existing machine is expected to cost $530,000 and have a useful life of six years. The system yields an incremental after-tax income of $295,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $11,400. b. A machine costs $510,000, has a $33,800 salvage value, is expected to last eight years, and will generate an after-tax income of $72,000 per year after straight-line depreciation. Assume the company requires a 10 % rate of return on its investments. Compute the net present value of each potential investment. (PV of $1. EV of $1. PVA of $1, and EVA of $1) (Use appropriate factor(s) from the tables provided.) Complete this question by entering your answers in the tabs below. Required A Required B A new operating system for an existing machine is expected to cost $530,000 and have a useful life of slx years. The system yields an incremental after-tax income of $295,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $11,400. (Round your answers to the nearest whole dollar.) -Present Value Cash Flow Select Chart Amount PV Factor X Annual cash flow Residual value Net present value Required B

Answer 1

Effective cash flow = Income after tax + Depreciation

Formula of Cumulative Discounting Factor = (1-(1+r)^-t)/r

where.

r = rate of interest

t= time period

PV = CF * (1-(1+r)^-t)/r

where.

PV = Present Value of future cash flows

CF = Annual Cash flow

r = rate of interest

t= time period( no. of years)

Formula of Discounting Factor for a particular year = (1+r)^t

where.

r = rate of interest

t= time period ( year)

PV = CF / (1+r)^t

PV = Present Value of future cash flows

CF = Cash flow

r = rate of interest

t= time period(year)

a.
Cash Flow	Select Chart	Amount	X	PV Factor	=	Present Value
Annual Cash Flow	PVA of $ 1	$381,433		4.355261		$1,661,240
Residual Value	PV of $ 1	$11,400		1.771561		$6,435
	Total Present Value of Future Cash Inflows					$1,667,675
	Initial Cash Outflow					($530,000)
	Net Present Value					$1,137,675

Working Notes
Given values
Cost of Machine = $ 530,000
Annual Cash Inflow = $ 295,000
Salvage Value of Asset = $ 11,400
Rate of discounting = 10%
Useful life of asset = 6 years
After tax Cash flow = Income after tax + Depreciation
Depreciation charged is on straight line basis
Computation of Depreciation
= (Cost of Asset - Salvage Value)/Useful life of asset
=( $ 530,000 - $ 11.400)/6
= $ 518,600/6
= $ 86,433
Total Yearly Cash Flow = $ 295,000 + $ 86,433
= $ 381,433
Cash Flow from salvage value in the sixth year = $ 11,400
		Amount	PV Factor	PV of CF
Annual Cash Flow		$381,433	4.355261	$1,661,240
Residual Cash Flow		$11,400	1.771561	$6,435
Total Cash Flow				$1,667,675

b.
Cash Flow	Select Chart	Amount	X	PV Factor	=	Present Value
Annual Cash Flow	PVA of $ 1	$131,525		5.334926		$701,676
Residual Value	PV of $ 1	$33,800		2.143589		$15,768
	Total Present Value of Future Cash Inflows					$717,444
	Initial Cash Outflow					($510,000)
	Net Present Value					$207,444

Working Notes
Given values
Cost of Machine = $ 510,000
Annual Cash Inflow = $ 72,000
Salvage Value of Asset = $ 33,800
Rate of discounting = 10%
Useful life of asset = 8 years
After tax Cash flow = Income after tax + Depreciation
Depreciation charged is on straight line basis
Computation of Depreciation
= (Cost of Asset - Salvage Value)/Useful life of asset
=( $ 510,000 - $ 33800)/8
= $ 476,200/8
= $ 59,525
Total Yearly Cash Flow = $ 72,000 + $ 59,525
= $ 131,525
Cash Flow from salvage value in the sixth year = $ 33,800
		Amount	PV Factor	PV of CF
Annual Cash Flow		$131,525	5.334926	$701,676
Residual Cash Flow		$33,800	2.143589	$15,768
Total Cash Flow				$717,444