Question

Heron Corporation is planning to add manufacturing capacity by installing new high-tech machines. The machines would increase revenues by $180,000 per year and increase costs by $50,000 per year. The new machines cost $560,000 and would be depreciated over 5 years using simplified straight line. Investment in net working capital of $30,000 would be required at the time of installation. The firm is planning to keep the machines for 7 years and then sell them for $80,000. The firm has a required rate of return on investment projects of 13% and a marginal tax rate of 34%. What is the net present value of this project?

Correct Answer $41,409

*Step by step using calculator please show math, thumbs up guaranteed <3

Answer 1

Solution:

Annual depreciation till year 5=$560,000/5

=$112,000

Initial Cash outlay=Cost of machine+Net working capital requirement

=$560,000+$30,000=$590,000

After tax Annual cash flows till year 5=[Sales-Cost-Depreciation][1-tax rate]+Depreciation

=[$180,000-$50,000-$112,000][1-0.34]+$112,000

=$18000[1-0.34]+$112,000

=$123,880

Since after 5th year,there is no depreciation,hence after tax cash flows for the year after 5th year is;

=[Sales-Cost][1-tax rate]

=[$180,000-$50,000][1-0.34]

=$85,800

Terminal cash flows(At year 7th) is;

=After tax sale proceed of machine+Working capital recovery

=$80,000(1-0.34)+$30,000

=$82,800

Calculation of NPV:

NPV=[Present value of cash inflows+Present value of Terminal value]-Initial cash outlay

Present value of cash inflows=Annual after tax cash inflows till 5th year*PVAF@13% for 5 year+Present value for 6 and 7 year*PVIF @13% for 6th year and 7th year

=$123,880*3.5172+$85,800*0.4803+$85,800*0.4251

=$513,394.06

Present value of terminal value=Terminal value*PVIF@13% for 7th year

=$82,800*0.4251=$35,198.28

NPV=($513,394.06+$35,198.28)-$590,000

=-$41,407.66 or -$41,408