Question

ABC Industries, Inc., needs a new lathe. It can buy a new high-speed lathe for $0.95 million. The lathe will cost $33,100 to run, will save the firm $131,300 in labour costs, and will be useful for 11 years. Suppose that for tax purposes, the lathe will be in an asset class with a CCA rate of 25%. ABC has many other assets in this asset class. The lathe is expected to have a 11-year life with a salvage value of $118,000. The actual market value of the lathe at that time will also be $118,000. The discount rate is 13% and the corporate tax rate is 35%.

What is the NPV of buying the new lathe? (Round your answer to the nearest cent.)
NPV    $ ______

Answer 1

Please comment if the solution is correct

The NPV (Net Present Value) is simply the difference of Aggregate of Present value of all cash inflows and aggregate of present value of all cash outflows.

There are three types of cash flow associated with the purchase of the lathe machine:

1. Initial Investment (Purchasing cost plus cost to run machine)

2. Annual Savings ( After 25% percent depreciation tax will be deducted and then depreciation will be added back and then total of the present value is calculated)

3. Terminal Cash Inflow: (Inflow from selling the scrap after 11 years i.e. termination of the project and then getting the present value of the amount to be received at the end of 11th year)

Here, 1 is cash outflow whereas 2 and 3 are cash inflows.

	Year	1	2	3	4	5	6	7	8	9	10	11
	Annual Savings	131300	131300	131300	131300	131300	131300	131300	131300	131300	131300	131300
Less	Running Cost	33100	33100	33100	33100	33100	33100	33100	33100	33100	33100	33100
	Net Income	98200	98200	98200	98200	98200	98200	98200	98200	98200	98200	98200
Less	CCA Deduction @ 25%	237500	178125	133593.8	100195.3	75146.48	56359.86	42269.9	31702.42	23776.82	17832.61	13374.46
	Income before tax	-139300	-79925	-35393.8	-1995.31	23053.52	41840.14	55930.1	66497.58	74423.18	80367.39	84825.54
Less	Tax @ 35%	-48755	-27973.8	-12387.8	-698.359	8068.73	14644.05	19575.54	23274.15	26048.11	28128.59	29688.94
	Income after tax	-90545	-51951.3	-23005.9	-1296.95	14984.79	27196.09	36354.57	43223.42	48375.07	52238.8	55136.6
Add	Depreciation	237500	178125	133593.8	100195.3	75146.48	56359.86	42269.9	31702.42	23776.82	17832.61	13374.46
	Net Annual Cash Flow	146955	126173.8	110587.8	98898.36	90131.27	83555.95	78624.46	74925.85	72151.89	70071.41	68511.06
	PV factor @ 13%	0.884956	0.783147	0.69305	0.613319	0.54276	0.480319	0.425061	0.37616	0.332885	0.294588	0.260698
	Present Value	130048.7	98812.55	76642.9	60656.22	48919.64	40133.47	33420.17	28184.1	24018.27	20642.22	17860.67
Add	PV of terminal Cash Inflow	30762.32
	Aggregate of present value of cash inflow	610101.2
	Initial Investment	950000
	NPV	-339899

From the solution we can see that the NPV of the project is negative therefore the project is not profitable and not recommended for investment.