Question

5. CAD Corporation is considering some new equipment whose data are shown below. The equipment has a 3-year tax life and would be fully depreciated by the straight-line method over 3 years, but it would have a positive pre-tax salvage value at the end of Year 3, when the project would be closed down. Also, additional inventories would be required, but it would be recovered at the end of the project's life. Revenues and other operating costs are expected to be constant over the project's 3-year life. Would this new equipment purchase decision is correct based on the project's NPV? (20 marks) WACC Net investment in fixed assets (depreciable basis) Required inventories Straight-line depreciation rate Annual sales revenues Annual operating costs (excl. depreciation) Expected pre-tax salvage value Tax rate 10.0% $70,000 $30,000 33.333% $75,000 $30,000 $2,000 35.0%

Please do not use Excel to solve this problem, using financial calculator and show steps.

Answer 1

NPV Analysis
Net investment in Fixed assets		-70000
NWC outlay in inventories		-30000
Annual sales revenues	75000
Less: Annual Opg. Costs	30000
Pre-tax income	45000
Less:Tax at 35%(45000*35%)	15750
After-tax income	29250
PV of after-tax income
29250*2.48685		72740.36
P/A,i=10%;n=3 yrs.
(1-1.1^-3)/0.1=2.48685
PV of annual depn. Tax shields
(70000*33.333%*35%)=
8166.59*2.48685		20309.08
PV of after-tax salvage
2000*(1-35%)/1.1^3		976.71
NWC recovered
30000/1.1^3		22539.44
NPV of the project		16565.60
YES. The purchase decision is correct as the NPV of its cash flows is POSITIVE.