Question

Greer Law Associates is evaluating a capital investment proposal for new office equipment for the current year. The initial investment would require the firm to spend $50,000. The equipment would be depreciated on a straight-line basis over five years with no salvage value. The firm's accountant has estimated the before-tax annual cash inflow from the investment to be $15,000. The income tax rate is 40 percent, and all taxes are paid in the year that the related cash flows occur. The desired after-tax rate of return hole robe 157. is 15 percent. All cash flows occur at year's end.

Answer 1

4)

Net Present Value is one the technique that is used to evaluate capital investment proposals,

So, here we shall evaluate the proposals using Net Present value (NPV).

Net Present value (NPV) = Present value of total cash inflows - Present value of total cash outflows

Depreciation for a year = (Cost of the asset - salvage value) / Expected useful life of the asset

    = ($50,000 - 0 ) / 5

= $10,000

Present value of total cash outflows:

Initial Investment is $50,000.

Total cash outflow is $50,000.

Present value of total cash inflows:

Annual before-tax cash inflow = $15,000

Add: Depreciation (Non Cash Expense) = $10,000

Net annual cash inflow before tax = $25,000

Less: Tax @ 40% = ($10,000)

Net annual cash inflow after tax = $15,000

Desired after tax rate of return(Discount Rate) is 15%.

Present value of total cash inflows = Net annual cash inflow * Present value of annuity factor at 15% for 5 years

= $15,000 * 3.353

= $50,295

Net Present value (NPV) = Present value of total cash inflows - Present value of total cash outflows

= $50,295 - $50,000

= $295

The project is viable and can be accepted as the Net present value is positive.